Shared equity and consumer credit legislation

Posted by Claire Waring on November 1 2012 in Commercial development , Residential development

What is shared equity and how does it work ? 

There are a raft of shared equity schemes currently being offered by house builders in a bid to boost their plot sale numbers.

Open the local paper and they're all there: "Pay for 75% and get 25% free for up to 10 years!", "100% yours, only 75% cost", "Pay just 85% of the price now and the rest within 10 years!"

Obviously, it is hoped that giving first buyers the opportunity to own 100% of their new home for as little as 75% of the price, will make it easier for them to get a foothold on the property ladder.

Although these kind of incentive schemes are generally referred to in the house building industry as shared equity, this is in fact a misnomer: the house builder does not take an equity stake in the title to the property because 100% of the equity is transferred to the buyer on day 1 – more correctly the schemes provide for equity related deferred payments.

Although house builders call their incentives by different names, most of the schemes operate in the same way: by way of example, let’s assume the house builder is selling a £220,000 home and offering a 75% scheme. The buyer takes out a mortgage as normal for 75% of the purchase price - £165,000.  The house builder then provides the remaining £55,000 (the other 25%) via a second loan usually over 10 years. There is usually no rent or interest to pay on this second loan for at least 5 years.  Some house builders charge a low rate of interest during years 5 – 10 but many don’t.  A buyer can choose to pay off all or part of the second loan during the 10 year period. The payments will be based on the property’s "open market value" at the relevant time. Equally, a buyer can sell the property at any time and the house builder will be entitled to 25% (or whatever their share is at the time) of the open market value.

Are shared equity sales incentives regulated?

Because shared equity is secured by a second legal charge it is not classed as a regulated mortgage contract for Financial Services Authority (FSA) purposes and is therefore not subject to FSA regulation.

At one time, a second legal charge securing monies in excess of £25,000 was also exempt from regulation by the Office of Fair Trading (OFT).   However, as a result of changes to the Consumer Credit Act 1974 introduced by the Consumer Credit Act 2006 and which came into force in April 2008, this is no longer the case.  The legislation no longer prescribes a financial qualifying criteria and all second legal charges are now within the ambit of the OFT’s regulation.

How OFT regulation affects a house builder  

Under current consumer credit legislation any house builder offering “shared equity” sales incentives must have a consumer credit licence issued by the OFT.  In order to fully comply with the legislation the licence must be in place before the house builder advertises or markets the incentive and the licence number should appear in all promotional / marketing material.

What are the consequences of non-compliance with the legislation?

It is a criminal offence for companies to offer such second charge schemes without having a consumer credit licence. Directors of an offending house builder are also committing an offence and, upon conviction, will have a criminal record.