CML news & views
Issue no. 3 - 15 February 2011
Problems for first-time buyers
First-time buyers (FTBs) have a high political profile, and today we are attending a “summit” called by the housing minister, Grant Shapps, to discuss their plight. Both David Cameron and Grant Shapps have spoken in recent weeks about the difficulties faced by those who many believe should be considered a reasonable risk for a mortgage that would enable them to realise their aspirations to own their first home.
Whatever the outcome of today’s summit, the plight of FTBs will continue to be a feature of our regular discussions – as it has been in the past – with a range of government departments, including the Treasury, and other interested bodies, including the Bank of England, the Financial Services Authority, the Homes and Communities Agency and the Home Builders Federation.
Meanwhile, in his first speech to the CML at our annual conference last November, our new chairman, Colin Walsh, highlighted the need for innovation in the industry, especially to improve access to home-ownership for FTBs and hence support a sustainable market.
FTBs are often seen as a bellwether for the health of the wider housing market – a crucial, though not unique, source of liquidity at the lower end of the market that helps to create mobility for other people to move around within it. But affordability pressures for FTBs have been growing since the late 1990s, and have got much worse since the credit crunch.
In our view, today’s summit needs to focus on the causes of problems for buyers in the current market, and not on their effects (one of which is a small number of FTBs). The key points for the summit to address are:
- The fallout from the credit crunch, which has led to a shortage of funding that is affecting the whole market. Gross lending in 2010 totalled £136 billion, down from a peak of £363 billion in 2007. Over the same period, the number of transactions in the UK has declined from 1.6 million to fewer than 900,000. So, although there are specific difficulties for FTBs, they are not the only group of borrowers facing problems.
- Wholesale funding markets remain effectively closed, with only a small number of securitisation deals working their way through to completion.
- The shortage of funding has made it more expensive for lenders to raise retail deposits.
- Regulatory reforms mean that lenders now have to hold more liquidity and capital. Requirements to hold more capital to support lending at a higher loan-to-value ratio have a direct effect on many FTBs.
- Other prudential and conduct of business regulatory requirements restrict lending capacity in other ways. Firms are under pressure to pursue a cautious, risk-averse business strategy.
- Building societies are additionally affected by the regulatory requirements imposed by the new building societies’ sourcebook. This is particularly restrictive for smaller societies who have often sought to lend to FTBs in local markets.
- Lenders are continuing to re-build their businesses after the systemic shocks caused by the financial crisis and the recession. Their risk-averse approach is being reinforced by uncertainty about the UK’s economic prospects, future demand from borrowers and house prices.
- The UK suffers from a continuing and long-standing undersupply of housing, which puts upward pressure on property prices. It is estimated that less than 110,000 new private properties were completed last year, compared to an annual average of 180,000 between 2005 and 2008.
The funding shortage
The shortage of funding created by the credit crunch – coinciding with increased regulatory and other pressures on firms to reduce exposure to risk – has led many lenders to introduce lower maximum loan-to-value (LTV) ratios for their mortgage range. In many cases, this means that FTBs are paying significantly higher deposits, as shown in Table One.
Table One: Typical FTB deposit illustration
Before the credit crunch, a typical FTB borrowed around 90% of the property’s value. As a result, he or she often therefore paid a deposit of less than 40% of their annual income. But since LTV ratios have tightened, many FTBs are now paying a deposit equivalent to a year’s income.
Despite growing affordability problems, FTB numbers held up well until the end of 2007. Chart One shows they have slumped since then, but so has the number of movers. Chart Two shows that current levels of property sales are producing the slowest turnover of homes, relative to the size of the housing stock, for more than 40 years. So, we do not just have a FTB problem. The UK has dysfunctional housing and mortgage markets, one symptom of which is the low number of FTBs.
Chart One: Lending to FTBs (loans advanced)
Chart Two: Average property turnover in the UK (calculated based on property transactions and the housing stock)
Conservative lending criteria have led to lower LTV ratios and much greater dependence by FTBs on the bank of mum and dad. Those aged under 30 are now heavily reliant on parents and other relatives for financial support. We estimate that, in 2005, 38% of those aged under 30 required help with their deposit. Table Two shows that by 2009 an estimated 84% of FTBs in this group were assisted.
Table Two: Assisted FTBs
Perhaps a little surprisingly in view of the increased affordability problems, the typical age of FTBs has not changed dramatically in recent years. The median age of an FTB has remained at 29. But assistance from parents or other relatives has helped younger FTBs in particular, and helped keep the typical age of an FTB stable since 2007. The typical age of those FTBs who did not receive assistance (and were unlikely to be former owner-occupiers returning to the market) increased from 28 in 2005 to 31 in 2010.
Chart Three shows that the proportion of FTBs aged under 35 has remained fairly stable since 2005. This is partly because of demographic changes (there are now almost one million more UK adults aged under 35 than there were five or six years ago) and partly due to increased help from parents with a deposit (without this, many FTBs would have been forced to save for longer, and the average age on buying would have increased, perhaps significantly).
Chart Three: Age breakdown of FTBs in the UK, 2005 – 2010
Chart Four: Age breakdown of all FTBs by Government Office Region, 2010
A range of options can be considered to help FTBs overcome the particular problems they face, depending on their circumstances, the funding and availability of schemes, and the extent to which they are appropriate in individual cases. These include:
- Public and private low-cost home-ownership schemes. We have lobbied for a number of years for the shared ownership and shared equity schemes sponsored by the government to be made simpler for borrowers and lenders to work with. However, funding for low-cost home-ownership will be reduced in coming years. Shared ownership also does not get favourable capital treatment under the Basel rules that lenders must follow, and there are additional, specific restrictions on lending under the schemes for all small and medium-sized building societies.
Most of the main house-builders also operate shared equity schemes. Typically, they might allow a buyer to take out a mortgage for perhaps 75-85% of the purchase price, pay a minimum deposit of 5%, with the developer providing the remaining amount as an equity loan. The loan is usually for 10 years, but it is sometimes not clear what happens at the end of this period if the buyer is unable to repay it. There is no public data available on how many of these loans are taken out or how many are repaid within their terms.
- Developers’ schemes, under which they match the deposit put down by the borrower, up to 10%. The developer provides this money as an interest-free loan for up to 10 years.
- Schemes run by some lenders and developers under which family or friends may provide a deposit, on which they receive interest for a period.
- Insurance to offset the lender’s risk. Some lenders and developers are exploring the potential for this to allow them to offer mortgages at higher LTV ratios with lower risk and possibly without the associated higher capital cost.
- Mortgages taken out by multiple borrowers. This could allow parents to add their income to their children’s, depending on their financial and other circumstances.
- Mortgages which allow the savings of family members to offset the loan. However, this does not help with deposit requirements or enable access to the lower mortgage rates associated with lower LTV mortgages.
- Guarantor mortgages, which are becoming less common but allow a family member’s income or property to be taken into account to give access to preferential rates of repayment.
- Discounted mortgage rates for existing current account customers.
- A range of free valuation and legal fees or cashback deals that can help reduce the costs associated with buying with a mortgage.
While each of these schemes may offer something to FTBs depending on their individual circumstances, there are also constraints on the extent to which they are available. The continuing shortage of mortgage funding, the shortage of government funding for schemes, and the regulatory pressures on firms are all bearing down on the capacity to offer help targeted at FTBs.
Future prospects for FTBs
The housing market recession we experienced in the early 1990s resulted in a protracted loss of appetite for home-ownership among FTBs. But that appetite returned as market conditions slowly improved. Our research shows that 85% of all households aspire to be home-owners in 10 years’ time.
Demographic factors point to an increase in the number of potential FTBs in the next decade, when the number of people in the 18-35 age group is projected to increase by 800,000. Demand for housing from young people will therefore be strong, and we expect FTB appetite to return as and when market conditions improve.
But although the housing market has stabilised over the last 18 months or so, we are forecasting only a tentative and relatively weak recovery from here. We expect there to be only around 860,000 property transactions this year. Around 30% of these will be cash sales, implying only around 600,000 mortgage-financed transactions, and perhaps 200,000 to 225,000 FTBs this year, similar to the low levels we have seen in each of the last three years.
Looking beyond this year, a return of more normal mortgage funding conditions is probably a prerequisite – but will not, in itself, be sufficient – for a significant return of FTBs. More widespread availability of funding could help bring about an easing of LTV requirements, potentially decreasing the dependence of FTBs on parental support.
Balanced against this, however, are the regulatory requirements for lenders to hold more capital for lending at higher LTV ratios. Under Basel rules, lenders typically may have to hold six to eight times as much capital for a mortgage advanced at an LTV ratio of more than 90% than the capital required for a loan with an LTV ratio below 60%. And in order to generate sufficient return on capital, many lenders therefore make borrowing at higher LTV ratios more expensive.
More generally, we expect affordability pressures to persist, given that any significant decrease in the ratio of house prices to earnings is unlikely (particularly given the low levels of house-building we expect in the foreseeable future, which will help underpin house prices). On top of this, other regulatory changes, including those emerging from the mortgage market review, are likely to increase mortgage costs for all borrowers and bear down on the availability of mortgage credit for FTBs.
All this suggests that FTB numbers will only recover slowly over time, and may take several years to approach the annual rate of 400,000 to 500,000 purchases that we have seen historically, and which would be supported by demographic factors and long-term aspirations to home-ownership.
What else could be done?
There is significant political appeal in measures that purport to get FTBs on to the housing ladder. Extending home-ownership is seen as an important means of promoting asset-based welfare and reducing inequalities in wealth and opportunity. However, in seeking to implement measures to help FTBs, there are a series of challenges:
- defining eligibility (although HM Revenue & Customs now has a strict definition of FTBs who are exempt for stamp duty obligations);
- administrative complexity;
- costs to the government, not least because the benefits of any schemes tend to be fully and permanently vested in those households that qualify for them, and are not recycled to other groups of FTBs;
- inefficiency, in particular if they help households that would eventually get on the housing ladder by their own means (although perhaps in different locations or later in life) or those that are unable to sustain owner-occupation;
- unfairness, if they simply help one group of potential FTBs at the expense of another, with the risk of inflating house prices for those that are excluded, unless they also create new sources of housing supply.
There are other major hurdles to overcome. At this stage, it is impossible to predict when lenders, collectively and individually, will have access to sufficient funding to meet demand from all those who would like to be home-owners. While the funding shortage persists, FTBs are among those groups of would-be home-owners who will continue to find it difficult to obtain mortgages. Additionally, there is a real risk that regulatory reform will reinforce the barriers to home-ownership for FTBs.
Before looking towards solutions, it is important to have a clear understanding of the extent of the underlying problems. A range of initiatives - including shared ownership, product innovation and mortgage insurance - could all potentially play a part, but none is likely to be a "magic bullet" that restores normality to the mortgage market, for FTBs or anyone else. This is likely to be a gradual process as confidence in funding markets and lending decisions is restored.