Wednesday, 24 February 2016

Economic myths: mortgage affordability

From The Evening Standard:

However, historically low mortgage rates meant that first-time buyers only had to pay nine per cent of their income as mortgage interest, the lowest proportion since records began in 1973. Interest and capital repayments combined accounted for 19.5 per cent of earnings.

The "nine per cent" figure is irrelevant. Think about it - if mortgage interest rates were zero, house prices would go up accordingly and annual repayments would remain the same. What matters is total repayments and for how long.

The blue line in this handy chart from Savills shows that twenty per cent for the first year is par for the course (remembering that this is calculated on gross income before tax; it is more like one-third of net income). Interest is like privately collected land value tax, a reduction in the tax rate benefits landowners and sellers, not buyers.

For more important is the red line, which shows that in the good old days of high inflation, your mortgage was being eroded away and your payments in real terms fell quite markedly. This is what the oldies conveniently forget.

A final point to mention is that mortgage terms are getting longer and longer, paying one-fifth of your gross income for ten or fifteen years is fair enough; paying it for thirty years is not.

11 comments:

Steven_L said...

And when those lines cross, that would be deflation, something our central bankers keep telling us we're under serious threat of.

If thee next generation stop taking out mortgages, then in the absence of HMT handing out ten pound notes like confetti, the deflation begins.

It's just like a pyramid scheme, where the current participants pay the previous and rely on an ever-expanding supply of new ones.

Except there aren't enough, so a blind eye is turned to iffy BTL lending and slum landlords making living spaces for transient minimum wages workers smaller and smaller.

Graeme said...

are they presenting thsat chart in ral terms? It makes no sense to me as someone in the 1980s subject to 15% inflation, and thus a 4 times multiple of mortgage to income.

Mark Wadsworth said...

SL, yes, presumably the lines will cross over and your mortgage will become a larger share of your income as time goes on (falling wages, higher taxes on wages, perfectly plausible).

G, how do you mean "real terms"? It shows mortgage repayments as a percentage of income.

Clearly, there was an unpleasant period 1988 - 1992 when house prices AND interest rates were high but that only affected recent purchasers.

It was hardly worse than the 2006 - 2008 period and as a bonus, those who'd been through that saw their repayments fall to 15% of income and falling AND made decent capital gains in the subsequent period.

Mark Wadsworth said...

SL: "in the absence of HMT handing out ten pound notes like confetti…"

They do, it's called "Help To Buy", in London they will lend first time buyers up to £240,000 interest free to keep the bubble expanding.

L fairfax said...

"The "nine per cent" figure is irrelevant. Think about it - if mortgage interest rates were zero, house prices would go up accordingly and annual repayments would remain the same. What matters is total repayments and for how long. "
I find it depressing that the Evening Standard didn't know this. I am so glad that I only use it check the TV at night.

A K Haart said...

"paying one-fifth of your gross income for ten or fifteen years is fair enough; paying it for thirty years is not."

Unless you are a landlord with a BTL mortgage. This is what I find so iniquitous.

L fairfax said...

Surely the percentage of your gross income is not 100% important. It depends partly on your costs (some people pay little in commute others a lot) etc.
Also if my income went up 4x and my mortgage did as well, I would be quite happy.
Sadly I can't think of a better metric. Can anyone else?

Good post though on the whole. I wish I could read this stuff on the BBC.

mombers said...

The real WTF is that privately collected housing revenues are not like other goods and services, i.e. cost + a normal profit.

Dinero said...

also a factor is how incomes and the cost of the basic living expenses have risen or fallen since the 1970s.

Bayard said...

Mombers, actually very little of commerce is like that. Mostly it's profit = what the market will bear - cost.

Mark Wadsworth said...

LF, thanks.

AKH "Unless you are a landlord with a BTL mortgage"... who is paying one-third of his tenants' income towards paying off his mortgage (I was one of the first BTLers, this is exactly how it works).

M and B, we've had this discussion before. B, you are right, but in most markets the super-profits are competed away. Land is one of a few things where super-profits do not get competed away. In the end, in most markets, "what the market will bear" is cost-plus.

Din, some stuff is cheaper, some is more expensive, we consume more of some and less of others, it all evens out, but the "20% towards a mortgage" is the stable thing.