Fun With Numbers

From The Evening Standard:

In spring Chancellor George Osborne announced the £500 million rescue package giving buyers a loan to cover 20 per cent of their property.

The buyers - who must have a joint household income of no more than £72,000 - then have to find a minimum four per cent deposit, and can fund the remaining 76 per cent of the cost with a conventional mortgage. Deposit loans are interest free for five years and can be repaid when the property is sold.

Lucian Cook, director of research at Savills, said that lenders are punishing First Steps buyers with interest rates of about five per cent because of the initial loan they are taking out to help pay their deposits. A typical rate at the moment is 3.75 per cent but most lenders will have regard to the fact that there is some sort of equity loan in place and ask for a higher rate," he explained.

Well duh.

With all this economics stuff, you have to know what the starting figure is for a calculation. In the case of housing, The Maypole around which prices dance is rental values (which are very stable in the short or medium term), and we know from observation that there is an equilibrium between rents and monthly mortgage repayments (if one is much cheaper than the other, people will choose the cheaper option, and so the two will come back into line).

Therefore, initial monthly mortgage repayments can also be assumed to be very stable in the short term; if the rent for a home is £1,000 a month, then the initial mortgage repayments will also be in the region of £1,000 a month; but what happens if the lender knows that the purchaser is not paying interest on 21% of the loan (20/96)?

On the face of it, the purchaser's mortgage repayments for that flat would drop to £790 a month. Two things can happen: the vendor hikes the selling price to soak up the £210 x 12 months x 5 years interest saving; or the lender hikes the interest rate on the non-interest free part of the loan, which is what is being observed here. In other words, the buyer is indifferent between

a) a £96,000 mortgage @ 3.75% = £3,600 interest every year (there's no way they'd get such a low interest rate on such a high LTV mortgage, of course, they'd more likely be paying 5% or 6%)) and

b) a combination of £20,000 interest free and a £76,000 mortgage @ 4.74% = £3,600 interest every year.

Just sayin', is all.