House Prices, Interest Rates and Affordability

marc-h_2

Graham_Devon wrote: »

I didn't make any suggestion as to who is and who isn't.

I stated it's no good basing overall affordability of houses, on those who can afford mortgages.

Which has what has happened in this thread. Surely it's very simple to see why this comparison simply does not work?

If I show a graph stating that it costs Bentley owners with loans on their bentleys, 10% of their income each month, does that show Bentleys are affordable to the nation? Or does it show Bentleys are affordable to those who can afford bentleys?

Do you think the same applies to the graph posted above which is based on average mortgage payments against average wages?

nembot

Blacklight wrote: »

Try looking at homeowners average income and disregard the people who earn £7k. It skews your calculation.

I did say average wage was 26,000 not 7000

But let's look at it from my personal perspective, bought over 10 years ago...

Mortgage in 2000 was £177 per month, mortgage on the same property at 2007 prices would be £739 per month.

You can't say this is a normal increase in any sense of the word.

Graham_Devon

marc-h wrote: »

Do you think the same applies to the graph posted above which is based on average mortgage payments against average wages?

Yes. It's still looking at those with mortgage payments, i.e. those who already own homes.

Let's say house prices went through the roof. You needed a 100k deposit to get an "average" priced house.

The graph you posted would show the same. As all those people have already bought. It will ignore ALL those priced out.

What the second graph posted does show is that interest rates have fallen off a cliff, therefore, again, those with existing mortgages, have seen falls in payments.

Those just entering will be paying the same kind of interest levels as before the bust.

marc-h_2

Graham_Devon wrote: »

Yes. It's still looking at those with mortgage payments, i.e. those who already own homes.

Let's say house prices went through the roof. You needed a 100k deposit to get an "average" priced house.

The graph you posted would show the same. As all those people have already bought. It will ignore ALL those priced out.

What the second graph posted does show is that interest rates have fallen off a cliff, therefore, again, those with existing mortgages, have seen falls in payments.

It looks at the national average wage not the average wage of people with a mortgage. Maybe I misunderstood what you said though.

Blacklight

marc-h wrote: »

Do you think the same applies to the graph posted above which is based on average mortgage payments against average wages?

What it demonstrates to me is that the average wage line needs to be higher. For a lot a wage earners owning a house isn't even on their radar as they are 18 and working in McDonalds. The same can be said for the average first time car buyer, buying a Bentley isn't on their radar because they're 17 and working in McDonalds.

You really need to take into account the people who actually want to buy, not the whole population.

Good post though marc. Interesting.

Turnbull2000

True enough.

However, although initial monthly payments may be lower on your 'cheap' debt, the cost over the entire 25 year period will be much, much higher. Higher rates were generally reflect in higher salary growth. This is no longer the case.

marc-h_2

The one thing I could never decide on was which way round this was working, even if you accept a link between house prices, interest rates and affordability. Do high house prices cause lower interest rates (partly) or lower interest rates cause high house prices (partly), or are the 2 not linked at all. People who ignore affordability and base a judgement on salary multiples are saying they aren't linked at all I guess?

andykn

nembot wrote: »

In the 80's people weren't paying 5 or 6 times their annual salary, like they have over the last few years.

But if you add up their payments then compared with now you'll probably find they were paying more.

princeofpounds

There's a lot of interesting comment on the thread but I want to keep my participation here brief in this instance, so I just want to address a point the OP may have missed.

But generally speaking he realises the most important thing that many people don't, which is to connect house prices and the cost of money. It is one of the main reasons why the typical political response just to extend more mortgage finance is ridiculous. People generally spend as much as they can afford on housing, which resembles a competition in the UK much more than it does a commodity that can be produced thanks to restrictive planning.

BUT the OP is also very limited in their thinking, treating this as a static problem rather than a multi-year dynamic problem.

There are important ways in which a low IR, high HP environment can be more unaffordable.

The first is in deposits - there will (crazy lending aside) always be an amount of skin that needs to be in the game before any financing can be obtained. This will become more expensive in such an environment no matter what.

The second needs the OP to consider more than the initial year (a common fault of people who treat financing as a static issue, and most do). The period of 'stress payments' is typically much more protracted in a low interest rate economy. Every year, you pay a % of the principal amount as your mortgage interest. The principal stays the same in nominal terms, but it gets eaten away in real terms by inflation.

A low interest rate economy is generally a low inflation economy, with low wage growth. If you start off paying 50% of your salary in interest, ten years later you might still be paying 40% of your salary - you will only slowly build up equity as the interest retains the power to eat your contributions for much longer.

But the value of the principal in a high inflation, high IR economy is quickly inflated away, and so the real (as opposed to nominal) burden of the mortgage quickly drops - 10 year at 10% inflation and it will seems like a piddling cost, although you have to pay the necessary interest in the meantime (but remember, that keeps prices low thanks to initial-year affordability). If anyone wants to see a more detailed explanation of this mechanism I might come back and do one later but hopefully it's clear.

This mechanism is actually the main way the preceding generation made much of it's 'profits' on housing - the houses did not only become way more expensive, it was after much of their debt was wiped out by inflation.

The third is to do with inequitable distribution of assets. In a low-interest economy asset prices boom. This provides much more wealth to those that already own them, and so they are able to increasingly outbid those with little wealth as not only are they even richer, but they have more access to finance as a result. This doesn't make property less affordable to all, but it does make it less affordable to those that do not already own some.

princeofpounds

The one thing I could never decide on was which way round this was working, even if you accept a link between house prices, interest rates and affordability. Do high house prices cause lower interest rates (partly) or lower interest rates cause high house prices (partly), or are the 2 not linked at all. People who ignore affordability and base a judgement on salary multiples are saying they aren't linked at all I guess?

Interest rates are set by a number of factors, but it's not too complicated to explain the main ones.

It's easier to conceptualise them as if you are the lender - you have some money, what would convince you to lend it to someone?

Well, you need to cover inflation first of all. What's the point of lending it out if the price of beer just goes up in the meantime?

You also need to compensate yourself for the cost of the money. Even if you already own it, you have the opportunity cost where you could do something else with the money and earn a return. Sticking it in the central bank is zero risk, so that's why Bank of England interest rates are important.

Then you need to cover the risk of lending it. Lending it to a government is low risk (they can just print some more, although that means you will need to charge more to cover inflation expectations). Lending on a house is riskier, but at least you have an asset you can repossess so it's not too bad.

Then you need some profit on top, so it becomes a beneficial rather than just a neutral decision. But that doesn't need to be large.

So, broadly speaking interest rates are set by expectations of inflation, central bank interest rates and risks of lending. There are different interest rates that apply to different clients and different time horizons.

The chicken and egg scenario comes because inflation is quite influenced by interest rates - the more available money is, the less value it has, and the higher inflation becomes as real assets become worth proportionately more.