Matthew Wyles is group development director at Portman Building Society
Like it or not, homebuyers are having to learn to live with high house prices. In an otherwise low inflation world where pay rises are generally modest, property values have broadly doubled in the last five years and tripled in a decade. The recent Bank Base Rate (BBR) increase will have put even more pressure on potential homeowners and, if speculators are to be believed, we could see a further rise within a few months.
Lenders have been looking at ways in which to make the market more accessible for new and returning entrants and loans with larger income multiples and so-called ‘lifetime’ mortgages are designed to help those struggling to get on the housing ladder. The affordability stretch has become particularly challenging for first time buyers (FTBs). As well as needing to borrow more, FTBs have had to find increasingly large lumps of cash since prime lenders typically require a deposit of 5 per cent of property value, while at least 10 per cent is normally needed to get the best mortgage deals.
No sign of abating
Saving even these amounts has become more challenging as property prices have soared. The present government believes there are about a million people in the UK who would like to own their own home, but cannot afford to do so.
This affordability crunch shows no sign of abating with the Council of Mortgage Lenders (CML) now forecasting a UK house price inflation rate of 7 per cent during 2006 – way ahead of earnings growth. Five years ago FTBs accounted for 43 per cent of all house purchases in the UK. By the end of 2005, this number had fallen to 37 per cent and the CML are now forecasting this figure will drop to 36 per cent by the end of this year.
At the same time, many FTBs are being squeezed by other debts, including student loans, and to cap it all, there is Stamp Duty. Despite the exemption for properties under £125,000, many FTBs, particularly in the South East, end up paying 3 per cent if they buy a property costing more than £250,000. In London, it’s not surprising that around one quarter of FTBs pay over £250,000 for their first property – well over the current Stamp Duty threshold. Is it any wonder that all the data shows that people are taking longer and longer to get into home ownership? With the average price now paid by FTBs in the UK of more than £140,000, the Royal Institution of Chartered Surveyors has calculated that an increase in the Stamp Duty threshold to £150,000 from £125,000 would bring an additional 35,000 to 40,000 FTBs into the market every year.
Plenty of growth potential
The 100 per cent mortgage, a loan for the full value of a property, doesn’t require a deposit and thus has the obvious advantage of accelerating a buyer’s entry into the market. 100 per cent mortgages are also helpful to individuals coming back to the market, for example, as a result of marital breakdown or other change in circumstances. For these reasons, it is surprising that the 100 per cent market is still so small, dwarfed by the buy-to-let and non-conforming sectors. But there is plenty of potential for volumes to grow.
With hindsight, prospective homebuyers struggling to scrape together a deposit during the recent boom would have been better off opting for a 100 per cent product instead. Those who delayed buying while saving for their deposit, would have been faced with much higher property prices by the time they came to look for a purchase – getting in earlier without a deposit would have been cheaper in the long run. Many such buyers have had to settle for a smaller place or a less desirable location than they had anticipated. With a 100 per cent loan, taken out sooner, a FTB could have benefited from tax-free capital gains, which would have far outstripped any taxable earnings made on savings.
Of course, this argument only works if the home owner believes that house prices will continue to rise in the medium-term but, based on current fundamentals, this looks like a fair bet. In 2004, the Barker Review pointed out that over the last 30 years the UK experienced a long-term upward trend in real house prices – an average of 2.4 per cent per annum. To bring the real price trend in line with the EU average of 1.1 per cent, an extra 120,000 new homes are required each year. Without a radical change in the rate of new housing starts and a complete overhaul of the current planning regime, this just isn’t going to happen.
Tailored for first-timers?
A 100 per cent mortgage can cost up to 1 per cent per annum more than the best conventional products but they generally don’t carry a higher lending charge (HLC). As a very rough rule of thumb, house prices still only need to keep pace with general consumer inflation for 100 per cent mortgage customers to be better off than renting. Going forward, that should be a compelling selling point. By extension, the more optimistic the outlook for house prices, the more popular 100 per cent mortgages should be.
100 per cent mortgage products tend to be designed to tackle typical FTB circumstances, including the need for income stretches, free valuations and low arrangement fees. Options include an interest only basis to keep early servicing costs low. Fixed rates are standard to reduce the risk of payment shock. By the same token, however, not all 100 per cent mortgages are available on a remortgage basis and many lenders focus on the first-time purchase market.
When the fixed or discounted rate period does end, assuming property prices have risen in the interim, borrowers may have built sufficient equity to shift to a prime market deal, without having to pay a HLC. Borrowers should always check that this is an option with their lender before signing up.
Sense without savings?
It should not be assumed that 100 per cent mortgages are only for those with no savings or without the ability to save. A 100 per cent loan could still make sense for someone with Independent Savings Accounts or other savings and investments they don’t want to encash. Such savings could provide the initial core of a repayment plan.
Similarly, a borrower might be better off with a 100 per cent mortgage if saving for a deposit would mean, for example, they cannot afford to contribute into a subsidised occupational pension scheme for their retirement.
The 100 per cent mortgage option needs to be seen in the context of a customer’s personal financial strategy – including considering it as a way of avoiding high cost borrowing elsewhere. For example, it could be that funding a deposit forces a borrower to run up credit card or unsecured debt to meet other living costs.
For lenders, the margins on 100 per cent loans are higher but so are the risks. In practice, any loan in excess of 75 per cent LTV ratio involves some potential for losses to be incurred on default but the credit risk increases dramatically as the LTV ratio rises towards 100 per cent.
Some 100 per cent mortgage schemes are targeted on the so-called professional or graduate customer segments. These seek to tap into the lower risk characteristics of customers who combine the prospects of rapidly rising incomes with a strong incentive not to acquire a credit impaired status.
Some FTBs may also have other options such as parental assistance. This could be as simple as a soft loan or a gift. More refined strategies include parents as guarantors or even as joint mortgagors. One advantage of a parent as joint mortgagor is that some mortgage lenders will include the parents’ income in their calculations, net of any existing mortgage commitment which the parents may still be bearing. This all assumes, of course, that the parents have experienced no serious credit impairment.
A joint mortgage with friends, siblings or partners is another possible solution, but such arrangements can end in tears and shouldn’t be entered into lightly. Most mortgagors are liable on a joint and several basis. If the partnership breaks down, the strongest borrowers may end up carrying the burden. Legal advice should always be sought in these cases before any commitment is made.
British mortgagors enjoy a diversity of products and propositions unrivalled by any other market in the world. 100 per cent mortgages have the potential to play an increasingly important role in this dynamic and responsive environment.
