Is It the Right Time to Buy a Home in London?
Amid repeated warnings of a high priced housing bubble, the London home prices have zoomed past those of its European peer cities. At current price levels, owning a home in London has become unaffordable for the common person. As of today, it is nearly impossible to purchase a house in London for roughly less than £300,000 ($453,000). A handful of properties available under that price tag belong to far flung areas on the outskirts of London, and are smaller in size for a family’s needs. Authorities have launched a few initiatives to assist home buying for common individuals.
This article explores the current situation of the London property market, and assesses if it is the right time for home buyers to purchase their dream house in London. (For related reading, see: How Much Money Do You Need to Live in London?)
The Price Rise of London Homes
There are a couple of reasons for this consistent price rise in the London real estate market. The capital city is the major financial hub of Europe, and has a buoyant job market. However, the real estate prices have been out of sync with the average wages in London. Compared to the majority of European countries using the single euro currency, the UK maintains its own GBP currency. This makes it a destination of choice for international investors looking for diversification through investment in the local property market. This consistent demand from foreign investors has contributed to a significant price rise in London. With the demand outstripping supply by a wide margin, the prices have risen consistently to higher magnitudes. (For related reading, see: Investing In Luxury Real Estate.)
How Does the UK Home Loan System Work?
A home buyer, willing to buy a property worth £300,000 through a home loan, should have at least 5% of the money with him or her (£15,000). The remaining 95% (£285,000) can be financed as a loan from a bank or a building society mortgage.
In addition to the 5% deposit money, an additional 3% goes towards stamp duty charges (£9,000), and another 0.5% (£1,500) towards legal fees, land registration, searches and related expenses. The total instant requirement for the individual buyer comes to £25,500, which is 8.5% of the total property cost of £300,000.
Beyond the 5% self contribution, the 95% amount can be sourced as a combination of a mortgage from a bank, and from a government scheme like “Help to Buy.” While the former starts charging interest from day one of the disbursement of the loan amount, the latter offers an interest free loan for the first five year period of home purchase.
The “Help to Buy” Scheme
The “Help to Buy” scheme was first launched in April 2013 all across the United Kingdom. It allows home loan amounts for 20% of the property value, and remains interest free for the first five years. With Help to Buy, a home buyer gets 20% as a government equity loan, contributes 5% as self deposit, and gets the remaining 75% as mortgage from a bank or a building society. Without the Help to Buy scheme assistance, the buyer would have been forced to take a loan of up to 95% property value. The majority of Londoners lack that eligibility as their annual income remains comparatively low.
The latest version of the Help to Buy scheme launched in autumn 2015 and has increased the zero interest home loan contribution from 20% to 40%. This offer is exclusively for new properties within the Greater London area and is for first time buyers only. It means that buying a home in London will now need only 55% as mortgage loan of the property value, against the earlier 75%. It will significantly reduce the heavy interest burden for first time home buyers in London, and make home buying more affordable. (For related reading, see: How You Make Money in Real Estate.)
The London Property Market
With a 20% contribution coming from the earlier version of Help to Buy, purchasing a property worth £300,000 would still need a loan of £225,000. To qualify for that amount of loan, an annual income of around £57,000 is required. With the Help to Buy contribution raised to 40%, the loan amount reduces to £165,000. This brings down the required annual income to £42,000 only.
Metro.co.uk reports that the median salary in the City of London stands at £48,023. The increase in the interest free loan limit to 40% allows the average London worker to qualify for purchasing a home locally, which was earlier out of reach with the limit of 20%.
Will the “London Help to Buy” Scheme Really Succeed?
The Help to Buy scheme was launched in April 2013.
However, the property rates in London have continued their upward movement. The high cost areas of Westminster, Kensington, Chelsea and Camden continue to be out of bounds for average UK residents, but areas even in the outskirts and suburbs of London have seen high price rises. (For more, see The Most Expensive Neighborhoods in London.)
Though the scheme looks beneficial on paper for individuals, there are concerns that this increase in interest free loan assistance from the government will further fuel the price rise. The challenge in London real estate market lies with high valuations, which can be tackled in two ways—allow the market to self-correct, or make more money accessible to individuals increasing their affordability to buy high valuation properties. The Help to Buy scheme fits the latter format.
Two big caveats with this approach are that it does not guarantee prices to come down (rather fuels them), and enables individuals to take loans beyond their capacities which otherwise they could not afford. After the initial five-year interest free period, the interest kicks in from the sixth year. The basic problem of high property rates remains unattended. Rather, it gets fuelled by more capital availability.
Similar past instances in other nations indicate easy capital availability leading to a further price rise. After home loan interest rates dipped to record lows in the year 2003 in Asian countries like India, the property prices shot through the roof. Individuals took high value home loans with low interest rates during that initial period. They had a tough time a few years later when rates shot up, increasing their repayment amounts.
The Bottom Line
The challenge in the London real estate market lies with the high valuations. The London Help to Buy scheme may help below average income earners initially, but affordability will remain a concern in the long run. Individuals should assess their financial positions both from a mid to long-term perspective, and then decide to go for high valuation purchases using such schemes. Impulsive buying without realizing the long-term repayment requirements may lead to financial challenges later.