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6. The Story So Far

The Current Position
The current house price rises started in 1996, the bottom of the last house price crash. Over that period the average house price as measured by the Land Registry has risen from £67k to £208k. The impact of rising house prices on the homebuyer has been significant.

To demonstrate this we will compare the affordability of the average house price to a couple, each earning the national average salary, at three points in time between 1996 and December 2007. The average salary is an excellent yardstick since it tends to grow only slowly over the long term, and is therefore useful for comparing house prices at different points in time.

 December 1996December 2000December 2006
Median Salary£15,700£18,848£23,600
Mortgage available at: 2.5 X joint salary (A)£78,500£94,240£118,000
Average house price (B)£72,144£109,558£207,573
Deposit Required (=B-A)None£15,318£89,573
Deposit as % of house price0%14%43%
Position of buyers: good or bad?GoodGoodBad

1996 Here we can see that property seems very affordable. The “Deposit Required” provides an idea of the monetary impact on the buyer. It can be seen that no deposit is required. Of course, 1996 was the bottom of the market so prices are relatively cheap. It is useful therefore to determine the picture further down the line, for example in 2000.

2000 A deposit is now required on top of the couple's maximum borrowings, but it is a modest 14%.

2006 The average couple must now find a £89,573 deposit (43%), which is likely to take many years of saving or significant help from family members. There will be very few participants in the housing market who can afford to buy the average house at these price levels.
Key Observations
It is clear from this simple analysis that the average house is currently not affordable to the average buyer. Or to put it differently, the average house price is too high - around double the average affordability. But just because the value of an average house seems “too high” does not mean prices will fall. Prices may continue to rise as buyers with average earnings buy smaller than average properties and buyers with higher than average salaries settle for average properties. Or, people may take on interest only mortgages which have lower monthly payments, so that they can afford properties otherwise out of their reach.

The banks also play their part in pushing house prices higher. If they adhered to their traditional lending multiples they would have been forced to stop lending to the vast majority of homebuyers long ago. However, as a result of the huge surge in global credit, banks have found themselves awash with money. In order to generate a return on their available funds, the banks have sought to lend out as much as possible by gradually relaxing their lending criteria. One way in which they do this is by moving away from using standard salary multiples and using affordability as a gauge of borrowing ability instead.

For example, for the average couple above, in December 2006 their mortgage of £118,000 results in mortgage payments of £760 per month (25 year repayment mortgage at 6%). Keen to obtain the maximum mortgage possible the couple may be able to demonstrate they can actually afford to pay more, say £1,100 per month. Under these circumstances the bank is then willing to lend an additional £52,000, giving them a total mortgage of £170,000. The immediate situation for these buyers now becomes much easier:-

                     Median salary£23,600                     
 Mortgage available(based on affordability) (A)£170,000                     
 Average House Price (B)  £207,573                     
 Additional deposit required (=B-A) £37,573                     
 Deposit as % of house price18%                     

Because they can borrow more, the deposit they require is now more manageable. However, indirectly the banks have increased the multiples of salary they are willing to lend out. The £170,000 mortgage is 3.6 times joint salary (£170,000 / (£23,600 x 2)), significantly higher than the traditional and time-tested 2.5 x limit.
Conclusion
The only way an average buyer can afford an average house at the present time is to borrow significantly more than has previously been possible under traditional lending criteria. The majority of buyers are therefore completely reliant on the willingness of banks to lend them vast sums of money.

In recent years buyers have got their wish as the surge in global money supply has fed its way into the banking system, expanding credit at an exponential rate. With so much money in circulation, and with intense competition within the banking sector, banks have made it easy to borrow money and home buyers have happily accepted larger loans.

With so much money chasing houses, prices have rocketed. The result is a housing market with extremely high prices, backed by massive levels of debt. So, under these precarious circumstances, what lies ahead for the housing market when the economy inevitably turns?

“At the beginning, prices are driven by fundamentals, and at some point, speculation drives them. It’s that old story: What the wise man does in the beginning, the fool does in the end.”  Warren Buffett.
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