Shared equity mortgages not best solution for affordability
U.K. program led to more house, not less debt
Whether or not the Liberal budget proposal to implement shared equity mortgages (SEMs) will improve housing affordability for first-time homebuyers has been the subject of some debate since the budget was released.
The full details of the SEM program have not yet been disclosed by the Canada Mortgage and Housing Corporation (CMHC), which has been entrusted with managing the $1.25-billion program over three years, but the basic outline would see the agency offer to take either a five- or 10-per-cent stake when qualifying first-time homebuyers purchase a home, depending on whether it is an existing or new-build home.
The Liberal government hopes to assist 100,000 firsttime buyers with the incentive.
What’s needed are aggressive plans that incentivize homebuilders ... to produce more housing of diverse types.
While government subsidized SEMs are new to Canada, other jurisdictions have tried them with varying levels of success.
A similar initiative by the U.K. government invested 10 billion pounds in the first five years of its launch in 2013.
A research paper released earlier in March by Mateo Benetton, a professor with the Haas School of Business at the University of California, and co-authors, presents a detailed review of SEM in the U.K. They concluded the households used SEM “to buy more expensive properties, and not to reduce their mortgage debt and house price risk exposure.”
There are a number of lessons to be drawn from the U.K. experience.
The U.K. government launched the Help-to-Buy Equity Loan scheme in April 2013.
The SEMs provided up to 20 per cent of the home purchase price “in exchange for the same share in its future value.”
Since houses are significantly more expensive in London, the scheme increased the equity threshold in February 2016 when it began to contribute up to 40 per cent of the purchase price for homes bought in London.
The scheme came with some restrictions.
Only newly built homes sold for 600,000 pounds or less were eligible.
Borrowers were required to put up a minimum down payment of five per cent.
Both first-time homebuyers and people moving between homes were eligible.
However, the scheme did not support the purchase of second homes or investment properties.
Also, the buyers were required to satisfy affordability requirements, one of which was a British version of the stress test.
For the first five years, the government charged a symbolic one pound per year in interest fees for the equity it provided. Afterward, the government charged 1.75 per cent in interest fees that increased each year by inflation plus one per cent.
The households, therefore, enjoyed an interest-free loan for the first five years and only later were charged interest fees on the balance they owed the government.
While the SEM maturity was set at 25 years, it could be terminated earlier by the sale of the house, prepayment, or default.
If the borrower defaulted, the government had the right to foreclose.
Prof. Benetton and co-authors compared 99,571 home purchases between April 2013 and March 2017 that benefitted from SEMs with 157,620 additional purchases that were eligible for the scheme, but in which the buyers chose not to participate.
They observed that the SEM borrowers were younger, more likely to be first-time homebuyers, had lower incomes and, on average, purchased properties that were seven-per-cent less expensive than those bought by the non-SEM borrowers who would have qualified regardless.
The SEM borrowers were more leveraged than their comparables such that the loan-to-value ratio was 91 per cent for SEM borrowers compared to 65 per cent for the comparables.
Similarly, SEM purchasers borrowed larger amounts relative to their incomes and their mortgage maturity periods were also considerably longer.
The experience in London revealed that when SEM contribution was increased from 20 to 40 per cent, qualifying homebuyers used the facility to purchase even more expensive units rather than reducing the mortgage amount.
Also, after the equity contribution was increased for London, borrowers bought even larger homes than before.
The question to ask is the following: What would SEM borrowers have done in the absence of the shared equity programs?
The researchers found that without SEM, the households would have either bought smaller, less expensive homes or they would have opted to rent.
Another interesting finding was that most of the eligible borrowers in the U.K. (61 per cent) did not take advantage of the SEM.
The authors believe that the borrowers were mindful of the future house price appreciation and were reluctant to share the expected capital gains with the government. The other less plausible explanation was that borrowers were not aware of the SEM scheme.
As the CMHC finalizes the SEM regulations for Canada, it must consider the lessons from the U.K., where SEM contributed to higher prices and facilitated the purchase of even bigger homes by first-time homebuyers.
At the same time, the majority of those who could benefit from the scheme decided not to.
Improving affordability in Canada’s most expensive housing markets will take more than SEMs.
What’s needed are aggressive plans that incentivize homebuilders and developers to produce more housing of diverse types to offset the increase in housing demand.
Such changes will require cutting the red tape that delays approvals, and streamlining levies and development charges to help build vibrant and sustainable communities.