Homeowners do feel more wealthy when the value of their house increases. But is this such a good thing for homeowners?
If the price of your house goes up, so does everyone else's!
Most people who move home progress up the property ladder as they want a bigger or better house. But this is when they realise rising prices may not be such a good thing after all.
If the value of your house has increased it is likely the house you want to buy has increased by the same percentage; and as the house you want to buy will most likely cost more you will end up devoting more of your income towards this oincreased cost.
Lets try this out with a few scenarios
It is often said in the media "and some good news for homeowners.... Houseprices have increased this month by xx% according to a report out today". But is this really good news?
House Price Inflation (HPI) is normally in accordance with the standard rate of inflation. When this is the case then this creates your equity. This equity then allows you to move up to the next step of the ladder. So when they say good news, what they are saying is that you have increased your equity and "in-theory" the amount of money needed to go up the ladder is less. Unfortunately, this is the way people think.
What people have to realise is that when they sell they then become a buyer. This means that if your house went up 5% then the one your buying may have gone up 5% or more. Which means that the gap (the monies you are paying minus your equity) is actually bigger.
Lets give examples:
The couple of 2000
The year is 2000 and Mr & Mrs X have bought their first home in Pleasantsville. They paid £70,000 for a nice 2 bed terraced. They like their house but have just started their family and have twins. This was planned but they could not afford a 3 bed semi at the time as it was £110,000. They earn £32,000 with their joint income (MR X £20,000 and Mrs X £12,000). Using the lending criteria at the time they could get 3x Mr X plus 1x Mrs. X which was £72,000 on a 100% mortgage. Thats £414 p.c.m. @ 5% IR. (21% of their take home pay). They could have stretched to the £650 month for the £110,000 semi (33% of their take-home pay), but the banks would not allow them to lend on them multiples.
Lets zoom to the year 2006... In 2006 their children are getting a little bigger and they decide that they need to move to a 3-Bed semi. They see on the news that house prices have have doubled since 2000 and are overjoyed. Their house is now worth a whopping £140,000! This means that with 5 years mortgage payments they own £62,000 that gives them £78,000 EQUITY!!! This is a great deposit for their next move. Until.....
They start looking for a nice semi and get a shock! The house they are looking for now costs £220,000! With their £78,000 deposit it means they have to find £142,000. Mr & Mrs X have been given an inflationary rise of 4% for the last 5 years which takes their income to £38,900, of which £24,300 is Mr X's Salary.
Using the OLD rule of 3x Main plus 1x Secondary that means they could borrow £87,500. This is a shortfall of £54,500!!! They are priced out of the market? The reason? That HPI has exceeded wage inflation by a MASSIVE amount.
However, when seeing their mortgage broker he says he has a solution. Most banks and Building Societies now ignore the rules that we have followed for years and base it on your affordability. They calculate that JOINTLY they can borrow 3.64 times their joint salary to get the £142,000 they need. Unfortunately Mrs X only works part-time as she has 2 children to rear. This makes her income £6,000 per year. On this basis they have a joint income of £30,000. This makes the multiple 4.73times their income but the lender agrees. This means they now have a mortgage of £830 p.c.m. (37% of their income)
They now PRAY that Interest rates stay low. They have a NETT income of £2,220 p.c.m. There are rising Utility Bills, Rising Council Taxes, Rising Petrol Costs and things are starting to get them down. They are in the house they wanted 5 years ago and they have now restarted their mortgage. They are paying more of their wages servicing their mortgage and are struggling to bring up 2 children.
Try telling these people that HPI is a GOOD thing?
The couple of 2006
Jon and Sally are 2 19 year old who are in love. They have just been engaged and want to start a family nest of their own. John works for an Insurance company in the city centre and Sally works in the local supermarket. John earns £17,000 whilst Sally earns £8,000.
They go to a mortgage advisor to find out that they can borrow a maximum of £59,000. They find out that there is NOTHING for sale for this amount of money. The advisor tells them that some lenders will lend based on affordability and asks for their financial information.
They have a NETT income of £1530 p.c.m. He finds them a mortgage for £125,000 just on the edge of new STAMP DUTY THRESHOLD. This will be £731 p.c.m. and is 48% of their total income. They have now been introduced to bills they never had to pay. Gas, Electric, Council Tax, Insurances, maintenance. They also dont own a car so have to pay for public transport to go to work. This has risen due to the fuel crisis. They have their starter home and "at least they are on the ladder".
The mortgage lender also charges them a Higher Lending Charge. The amount they are borrowing means they cannot get the best deals around. Instead of a 5% mortgage interest rates the best they can get is 5.4%. This now takes their payments to £760 p.c.m. (50% of their total income). The first year was tough. They could not afford any pleasures in life and were slaves to their debt. "We are 19 for gods sake, we should be enjoying our youth", Sally said. "I know. But it will get easier", Jon reassured here.
The following year, disaster struck. Interest rates rose 0.5% and they started to struggle. Tensions between the pair were starting to heighten. "I want a baby", cried Sally. "But we cant afford to bring a child up Sally. We are struggling to look after the two of us, nevermind a child", replied Jon. "Its not even our dream home either, It's alls we could afford"
"If only we were born 5 years earlier, this would not have happened", said Jon
As you can see. Whether you are a First Time Buyer (FTB) or an Owner Occupier (OO) then HPI has not helped you, but hindered you. If HPI went up in ratio to wages then this would not have happened but it has gone up TOO MUCH. Unless wages go up 100% in the next 5 years then these stories will remain realities.
If wages dont go up, then the prices will have to come down.
Todays homeowners are MEW'ing their properties to help their siblings get on the ladder! So FTB's affect current home owners!