Sunday, 17 August 2014

Economic myths: Mortgage affordability

Turnbull 2000 in the comments to the previous post:

House prices to average salary is an obsolete benchmark. It has been for a decade.

It's now about monthly affordability. With dual income, 30 year mortgage terms and low interest rates becoming the norm, a couple on 25K each can afford a property of £250,000. I've long expected UK house prices to settle at 6-7x average salary, perhaps 10x in premium areas.

OK, compare and contrast with fifteen years ago:

Nationwide median price paid by first time buyers Q2 2014: £159,804
Assume £15,000 deposit, mortgage repayments on 4% mortgage over 30 years, monthly repayment = £698 per month.
Median household income (guess) = £45,000 gross, so mortgage repayments = 19% of gross.

Nationwide median price paid by first time buyers Q2 1999: £55,618

Let's assume that the median wage has gone up by about half over that period so median income was £30,000, so the deposit which people could have saved up out of earned income was one-third lower and the amount which people could pay off each month was lower.

So £10,000 deposit, mortgage repayments on 6% mortgage over 15 years = £391 per month = 16% of gross £30,000.

So those who bought just in time before house prices went mad could have easily paid off their mortgage by now, the mortgage repayments were lower as a percentage of income to start with and by the end they were very affordable i.e. being nearly £300 a month less than what today's first time buyers have to pay, or only 10% of gross. The savings would be even more than that for a 1999 buyer who took out variable rate mortgages, which most did.

Today's first time buyers are stuck with a higher monthly payment for twice as long, with wages rising more slowly than retail price inflation.

The point is that a doubling in house prices mean that people pay twice as much for their mortgages, whether that's twice as much per month for the same mortgage term, or for a mortgage term which is twice as long is irrelevant. It's two ways of measuring the same thing. Twice as much is twice as much.

(And we don't even know whether Nationwide normalised their price paid figure for the fact that fifteen years ago FTB's were more likely to be buying a house and today they are more likely to be buying a flat.)


Lola said...

Your figures correlate with my professional experience. Had I the time it would instructive to research our archive which goes back to 1992.

Mark Wadsworth said...

L, to cut a long story short, mortgage repayments (net of MIRAS where appropriate) have stayed fairly stable as a % of incomes.

What has changed is that mortgage terms have doubled.

Woodsy42 said...

"The point is that a doubling in house prices mean that people pay twice as much for their mortgages,"

That is not logical - unless they are all paying the same mortgage rate.

The total payback cost (telegraph calculator) of a 25 year mortgage of £100,000 comes out as £160,000 at 4% or as £234,000 at 8%. That's not the same!

Alternately at 4% the purchaser could afford a house costing £140,000 for the same outgoing (and overall total) as the £100,000 house at 8%

The percentage of income figure is somewhat meaningless for a traditional mortgage because the payment falls as a proportion of income due to inflation.

Piotr Wasik said...

I have an impression that the current narrative is that you can "afford" a house if you can afford to pay current monthly repayment. Not much dwelling upon total cost over a lifetime of the mortgage or what happens if rates go up. Implicit assumption is that it is to be paid over the whole working lifetime of a borrower, like a tax. I almost hear them saying - what? you want to pay off and live mortgage free? it is cheating! You will still be occupying the property - and - for free!

Lola said...

MW Not enetirely the case. From the time I started in FS - about 1986 ish - mortgage terms were 25 years.

Mark Wadsworth said...

PW, I think interest rates are unlikely to go up for decades - but paying off a mortgage after retirement will become more normal.

L, yes, I know that people have long been going for 25 years, in which case, the 1999 buyers would have had initial payments £297.

Mark Wadsworth said...

W42, you are now just making it up as you go along so there's not much point debating with you.

Fact is, twice as much = twice as much, it would take some leap of mathematics to disprove that.

Lola said...

MW - "I think that interest rates are unlikely to go up for decades". That's a pretty sweeping prediction. Your reasoning is?

Mark Wadsworth said...

L, it's not reasoning as such, but if you look at really long term interest rate charts, the 1970s and 1980s were a weird spike, before and after this we are looking at 2% - 4% as 'normal'.

Plus most western economies are based on huge piles of debt and inflated land prices so the pol's think they have to keep interest rates low.