First-timers: a special case - or just another excluded customer group?
Published: 17 May 2011 | Author: Bernard Clarke
What can be done to help more first-time buyers on to the property ladder? Many believe the answer to this question is crucial to unlocking the housing market, and prospects for first-time buyers have been widely debated in recent months. We agree that, as a group of consumers, first-time buyers have not been well served by housing and mortgage markets recently. But it is important to understand clearly why this is so.
We have therefore spent a lot of time analysing the problems for this group, and potential solutions – both before and after February’s first-time buyer summit hosted by housing minister Grant Shapps. The focus on problems for first-time buyers by the lending industry and the government has led to the launch of a number of innovative mortgage products and potential solutions by lenders, builders and others. And in his Budget in the spring the chancellor unveiled details of his new FirstBuy scheme.
Some of these measures will help some first-time buyers in some circumstances. But none provide a holistic solution to the levels of pent-up demand in the market.
We have briefed the housing minister on our analysis of the problems for first-time buyers. Our key conclusion is that there is no ‘magic bullet’ solution. From the industry’s perspective, an initiative designed specifically to help first-time buyers potentially has as many potential down sides as benefits for the market.
We believe that, in the prevailing conditions in the mortgage market – which has stabilised but remains fundamentally dysfunctional – first-time buyers are just one group of consumers (admittedly perhaps the one with the highest profile) that is not being well served. Others include ‘second steppers’, borrowers in negative equity as a result of falling house prices, and customers with existing mortgage products that are now no longer available in the market.
‘Second steppers’ include a significant proportion of existing first-time buyers, many of whom have surmounted the initial problems but may have taken out their mortgage shortly before the financial crisis. Many now find themselves with only limited equity in their home, a shortage of potential buyers, and an inability to borrow as much as they would like to make the next step up the property ladder.
Wider mortgage market conditions
In our view, problems for first-time buyers can only be properly understood in the context of the wider mortgage market, which has seen a pronounced decline in activity since the onset of the credit crunch. Our data shows that gross mortgage lending has declined by more than 60% in three years, from £363 billion in 2007 to £136 billion last year. There is little prospect of recovery in the foreseeable future, and our forecast this year is that lending will be virtually unchanged, at £135 billion.
Within the context of this sharp decline in activity, the reduction in remortgaging has been particularly pronounced. In 2010, remortgaging accounted for 29% of lending, compared to 47% of a much larger market overall in 2008. Given the continuing shortage of mortgage funding, any recovery to the levels of remortgaging we saw prior to 2008 may now be decades away. The upturn in remortgaging in the first three months of this year was welcome but is unlikely to be the precursor to a renaissance of the remortgage market.
First-time buyer activity
The combination of a shortage of mortgage funding, declining house prices in many regions, evolving regulatory pressures and an aversion to risk in the market has produced a sharp decline in borrowing relative to property value. Table One shows the dramatic impact on first-time buyers of the removal over the last couple of years or so of mortgages allowing customers to borrow 95% or more of the property’s value, and the move towards lower loan-to-value products.
Chart One: First-time buyer mortgage distribution: proportion of loans by loan-to-value band
Even before the credit crunch, first-time buyers had begun to adjust to growing affordability problems by taking out mortgages over a longer term. Table Two shows how this has become increasingly more common since 2005, with almost half of first-time buyers now opting for a mortgage term of more than 25 years.
Last year, however, the Financial Services Authority (FSA) proposed that lenders should assess mortgage affordability for borrowers on the basis of a term of no more than 25 years. Our data clearly shows that this would have erected a significant barrier to home-ownership for an increasing number of first-time buyers. We therefore welcome the FSA’s recent confirmation that its proposal has been dropped.
Regulatory pressures and the risk-averse lending environment are the main reasons for a decline in interest-only borrowing by first-time buyers and an increase in the number of capital repayment mortgages, as shown in Chart Three. This does not imply that interest-only borrowing is a bad thing. But the pattern we have seen recently is being reinforced by the FSA’s proposal that checks on affordability should require the borrower to show they can afford a repayment mortgage.
Chart Three: Methods of repayment of first-time buyer mortgages
Despite the more challenging conditions for first-time buyers, their age profile has changed little, as Chart Four shows.
Chart Four: Age breakdown of UK first-time buyers, 2005 – 2010
The biggest challenge for most first-time buyers is in the size of deposit they now pay, relative both to income and property value. Table One shows how rapidly this has changed in a short period of time.
Table One: First-time buyer characteristics
|Q1 2007||Q1 2008||Q1 2009||Q1 2010||Q1 2011|
|Deposit as % of income, median||41%||46%||86%||92%||87%|
Help for first-time buyers
So, what can be done to ease the constraints on first-time buyers? One of the biggest challenges is trying to help within the context of a wider mortgage market that remains heavily constrained by a shortage of funding. This imposes its own restriction on the capacity or appetite of firm to innovate or take on risks associated with groups falling outside a safe core of low-risk customers – those with impeccable credit records seeking to borrow at low loan-to-value ratios.
Regulatory reform and new conduct rules are reinforcing these trends. Put simply, mortgages with a loan-to-value ratio of over 90% typically require eight times as much regulatory capital as those with a ratio below 60%.
Although we favour more intensive and intrusive regulatory supervision, lenders have responded to pressures to squeeze risk out of their businesses. This reinforces the barriers against first-time buyers with small deposits – one of the groups of customers associated with higher risk.
Fundamentally, the main barrier is that lenders essentially find it more difficult to take the risk associated with high loan-to-value mortgages, particularly those above 90%, partly because of its price. Where a firm is prepared to be more flexible, it typically requires additional measures to reinforce the borrower’s commitment or to offset the higher commercial exposure.
Firms are more likely show to engage where the risks are shared with other parties. The market has devised a number of ways of achieving this, including mortgage indemnity insurance and the use of guarantees, including deposit accounts for parents’ savings that pay interest but can be drawn upon by the lender if there are problems in meeting the mortgage commitments.
All of these options depend, of course, on having a partner willing to share the risk, whether it is an insurer, a guarantor, or the government (through initiatives like FirstBuy). Even then, regulatory capital requirements can be a barrier to preferential treatment.
Another approach is to help first-time buyers through products linked to behavioural understanding of the customer. Examples include regular savings schemes, which help a would-be first-time buyer build a deposit and also show evidence of a capacity to meet long-term financial commitments. But establishing a savings habit does not remove the barrier of a large deposit required for most borrowers.
So, is it all bad news for first-time buyers? Not entirely. The challenges are daunting, but not insurmountable – at least for some first-time buyers. From some lenders, we have seen welcome innovation in recent months, along with commitments from some firms to grow their mortgage business this year.
The government is also trying to help, despite the fiscal pressures under which it operates. In his Budget this spring, the chancellor unveiled the FirstBuy scheme, seeking to help builders and first-time buyers. It remains to be seen how successful this will be. The government has limited resources, and FirstBuy is modestly targeted to help 10,000 buyers over two years.
Although there have been a number of initiatives to help first-time buyers, the relatively small scale on which they operate – combined with a severe shortage of funding, and a risk-averse market environment – means that we do not expect there to be a significant increase in first-time buyer activity in 2011 or 2012. The reality for first-time buyers is that, although there is widespread sympathy for their plight, they are only one of a number of different types of consumer who are experiencing difficulties in challenging housing and mortgage market conditions.