Housing affordability continues to be a major issue and there is concern over whether government targets to help first-time buyers are achievable given the extent to which housing has become less affordable.
The situation for many first-time buyers is that they currently want to become home owners and would meet all the underwriting criteria for a mortgage, but because of prevailing house prices, interest rates and income levels, many are unable to meet the lenders’ ability to repay.
A recent study by Professor Steve Wilcox estimated that in 2004 there were 1.25 million UK households aged under 40 whose income would be too high to qualify for housing benefit if they were living in social rented accommodation, but too low to afford a mortgage. Over a fifth of households aged under 40 fall into this category and the figure is one in three in London, the South East and South West.
The average UK house price was more than £186,000 about 12 months ago, compared with a little over £100,000 in 2000. The strength of house prices reflects the number of developments, which include:
- A stable, low inflation economic background in which employment has been strong;
- Strong growth in the number of households; and
- The low level of house building.
Lenders have made great efforts by improving their underwriting processes and investing in systems that rely on individual assessments of monthly mortgage repayments relative to disposable income rather than crude income multiples. However, the issue of first-time buyer affordability remains a concern for those in the market.
A serious problem
Despite lender innovation and flexibility, affordability has become a serious problem for first-time buyers, and their numbers have shrunk over the past few years.
Another major factor now limiting first-time buyers is the need to raise a deposit. Five years ago, 50 per cent of first-time buyers took out a mortgage equivalent to 90 per cent or more of the purchase price. This proportion has since shrunk to below 40 per cent at the end of 2003 and 35 per cent in the past 12 months.
The impact of this on the typical first-time buyer can be assessed by looking at the median loan-to-value (LTV) ratio. This has fallen to around 87 per cent from 90 per cent at the turn of the decade. It means that the first-time buyer now has to raise a deposit of £12,000-£17,000 – equivalent to over 50 per cent of than average gross annual household income – compared with £6,150, equivalent to a quarter of annual income, five years ago. The Council of Mortgage Lenders’ (CML) research on first-time buyers in 2005 provides a more detailed overview of first time buyer trends. The proportion of first-time buyers with high LTV has fallen very significantly and those taking out high income multiple loans have grown rapidly across all areas in recent years. Affordability is most of an issue in Greater London, the South East and the South West, followed by East Anglia and the Midlands.
Home ownership is made even less affordable in these regions by Stamp Duty. Even after the doubling of the nil threshold in the March 2005 budget, Stamp Duty is applied at a rate of 1 per cent on purchase prices above £125,000 and up to £250,000. Average first-time buyer house prices confidently exceed the lower threshold in the least affordable regions and some were above in East Anglia, Midlands and Wales. For first-time buyers in the South, Stamp Duty raises the up-front cost of becoming a home owner by around £2,000.
According to Nationwide Building Society, the proportion of first-time buyers receiving assistance from parents to fund deposits have increased to 55 per cent at the end of 2004 from less than 30 per cent two years earlier, and that it is currently between 45 per cent and 50 per cent. Government statistics show that 23 per cent of first-time buyers are now relying on gifts or family loans in order to afford the deposit, compared with just 4 per cent 25 years ago.
But the figures only recorded the numbers who actually become home owners. The implication is that many who were unable to find support simply did not enter the market.
Lenders have tried to bridge this gap with guarantor mortgages, where the guarantor assumes responsibility for repaying the mortgage in the event of default by the borrower. Lenders have also introduced joint mortgages between parents and children, mortgages based on the income of more than two applicants and family products where interest is earned on the savings of family members can be used to offset the mortgage payments for the borrower. There is, however, a limit to how much assistance can be given and those without it may be forced to defer or reconsider house buying as an option.
A worsening situation
With a sharp increase in house price growth over the past 18 months, the accessibility constraint is worsening. A number of commentators address this point. Professor Miles’ analysis on this topic aims to explain why house prices have increased in recent years and concludes that a fall is likely at some future point, but that it is difficult to judge when.
Professor Stephen Nickell, former member of the Bank of England’s Monetary Policy Committee (MPC), believes that average household disposable income is relevant, as this includes other sources of income, the impact of tax changes and the fact that the proportion of two earning households have risen considerably over the past 25 years. He also argues that it is not unreasonable to restrict the analysis to the top 70 per cent of income earners because home ownership accounts for only 70 per cent of all tenure.
Professor Nickell’s house price to earning ratio has a much lower profile, but its current value – at around 3.7 – suggests that house prices are 30 per cent above their long-term average relative to incomes.
Although this measure indicates that house prices are high, this does not necessarily mean that house prices are fundamentally over valued or in danger of collapse. Many believe that the market is not dramatically overstretched and there is a number of reasons why the equilibrium level of house prices might have risen. These include:
The rate at which new dwellings are being built is at a historically low level, whereas the population working age and the net rate of formation of new households is relatively high;
The debt service costs in the early years of a loan are less in a low inflation and low interest rate environment, and;
The substantial and sustained falling in long-term real interest rates has lowered the real cost of long-term borrowing.
One reason why house prices might be higher relative to income is the stable level of interest rates compared with earlier decades. Since 2000, rates have moved in a 3.5 per cent-6 per cent range and averaged 4.6 per cent. This is compared with averages of 11.8 per cent in the 1980s and 7.9 per cent in the 1990s. This means borrowers can borrow more relative to income for the given level of monthly debt service. The independence of the MPC and the explicit inflation target gives borrowers confidence that mortgage interest payments relative to income will not prevent unsustainable levels by monetary policy action.
Although recent increases in mortgage arrears and bankruptcies suggest that a minority of households have over-extended themselves, there has only been a modest increase since the second half of 2004 and the bigger picture is that both remain at relatively low levels.
Indeed, lower interest rates over recent years may have already provided some relief for home owners. It is difficult to believe that there will be a material improvement in affordability over the medium-to longer-term unless the housing stock expands at least as fast as the growth in the number of households.
Setting targets
The poor responsiveness of house-building laws at the heart of the Barker Review recommended the government adopt a market affordability goal. The government recently announced that it intends to use house prices to earnings ratio as its headline measure of affordability. Regional targets for the headline indicator will be to improve access to the housing market over the long-term. If affordability were worse than target, there would be a requirement to increase housing supply to bring the ratio back on target. The timescale for the targets was announced when the government confirmed its national affordability goal in late 2005.
Lenders will continue to develop responses to the affordability pressures that first-time buyers face. While these will assist households at the margins of home-ownership, they oblige the government to lift rates of house building – the crucial factor affecting longer-term affordability.
