Mortgage costs fall to 2003 levels

A new Ability to Buy Index from RBS paints a mixed picture for first time buyers in Britain.

Related topics:  Mortgages
Millie Dyson
30th January 2012
Mortgages
While average mortgage payments have fallen to 2003 levels, it is now more difficult for first-time buyers to get a foot on the housing ladder than during the 2009 recession.

RBS says the quarterly Ability to Buy Index gives the most realistic picture available of the real squeeze facing first-time buyers in the UK.

Fionnuala Earley, RBS Group UK Consumer Economist, says:

“Our new index provides the most accurate picture available today of the squeeze on first-time buyers, by including the effects of tax, National Insurance, earnings and rising living costs, in addition to house prices and interest rates.

“Our first results show that higher living costs are making it more challenging for first-time buyers to enter the market, despite the lowest mortgage payments in almost a decade.

"But the news is not all bad - inflation is now beginning to fall and assuming earnings still rise and interest rates remain low, this should help to improve the ability for first time buyers to enter the market.”
 
The RBS FTB Ability to Buy Index has deteriorated for three consecutive quarters. At 98.6 in Q3 2011 compared with an average of 96.5 in 2009, the index also shows it’s harder to buy now than in the 2009 recession.

This contrasts with house price to earnings measures which suggest conditions have improved.

The rising cost of essentials during 2011 has outweighed the effect of falling house prices and rising incomes on the ability to buy.

Ability to buy has deteriorated most in the East of England, East Midlands and London since 2009. The biggest improvements were in Northern Ireland and the North East.

But the results also contain some encouraging news. Low interest rates mean that even with the squeeze on household income, the debt-servicing burden has fallen to 2003 levels.

In Q3 2011 a first-time buyer repayment mortgage took up just 52% of discretionary income (income after tax, National Insurance and spending on essential goods and services). At the peak of the market in 2007 this proportion was 84% and in 1990 it was as high as 123%.

But rising living costs have prevented this improving further. Compared with the 2009 recession, the debt servicing burden, after taking tax and living costs into account, improved by 5.8%. Measures based on gross income suggest it improved by 8.7%.

Low interest rates and squeezed discretionary income also mean that it will take a long time to save for a deposit, but not as long as in 2007.

Assuming that house prices stay still, earnings grow at a modest annual rate of 2.5% and FTB can save 30% of discretionary income, it would take three years to save a 10% deposit.

In London it would take eleven months longer, but in the in the North East it would take just 29 months to save a 10% deposit.

Fionnuala Earley, RBS Group UK Consumer Economist, continued:

“Traditional affordability measures only look at gross earnings, but the RBS Ability to Buy Index gives a more realistic approach by taking into account other essential calls on buyers’ incomes.

"It is particularly timely given the FSA’s emphasis on the assessment of borrowers’ outgoings in its latest proposals on mortgage regulation. But it’s also important at a time when inflation is putting such pressure on household budgets.

“It is a little surprising that even though house prices are falling and incomes have increased, FTBs are squeezed more now than they were during the 2009 recession. The rising cost of essential goods and services has eroded their discretionary income.

"But low interest rates are still a tremendous help. A 90% loan for a first-time buyer would take up just 52% of available income today compared with 84% at the market peak.

"This gives borrowers a much bigger financial cushion. But lower discretionary income and low interest rates mean saving for a deposit is still a hurdle.”

Ability to Buy

House price to income ratios have improved, but ability to buy is worse than 2009

First-time buyer house prices were 18% below their 2007 peak in Q3 2011. Over the same period, gross earnings increased by 10%.

The house price to earnings ratio fell from 6.7 to 5 as a result, suggesting a big improvement in affordability. But in fact this hasn't happened. The rising cost of living has squeezed households’ discretionary income and made their ability to buy to deteriorate.

The RBS FTB Ability to Buy index has increased for three consecutive quarters. (A rise in the index signals deterioration in the ability to buy.)

In Q3 2011 the index reached 98.6, up 2% from the 2009 average of 96.5 when the economy was in recession. In the year to Q3 2011, FTB house prices have fallen by 0.5% and after tax incomes have increased by 3.3%.

But, spending on food, transport and utilities increased by 7%. The rising cost of essentials has outweighed the effect of falling house prices and rising incomes on the ability to buy. And this is even without taking account of other spending on clothing or even rent.  

Regional Ability to Buy

Ability to buy has deteriorated most since 2009 in the East of England, East Midlands and London. In Northern Ireland and the North East it has improved. But this doesn't mean that these areas will see their housing markets recover rapidly.

There are other factors, particularly the labour market, which have an effect. For example Northern Ireland saw the largest improvement in ability to buy in Q3 2011, but this region also has the UK’s highest rate of labour market inactivity and an economy very dependent on the public sector.
 
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