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The 3.5 Times Earnings Debate

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This has been raised many times on HPC, that historically the earnings ratio in the UK is around 3.5 times salary. Higher in London, lower up North.

So it has been suggested that if the government could restrict borrowing to this level (ie proof of income from Inland Revenue). This would stop Joe Public getting himself into the brown stuff.

However it's not very fair in a low interest rate environment:

Joe Soap earns £40k, and rents a London flat worth £240k.Six times gross salary.

Rent costs £1200pm, £14400 a year.

So the place is generating a 6% gross rental yield.

Now Joe can get a mortgage at 4.75%, so it's going to cost him 11400k a year to buy (IO mortgage).

Now currently Joe can go to a mortgage company and borrow 6 times earnings.

By doing this he can save himself £3000 a year.

He has to do the maintenance, but he's quite handy and doesn't mind the odd bit of painting.

Now what do you guys think is fair?

1) Allow Joe to buy the place, save himself some cash each month, and he's happy knowing it's "his" place. It may fall in value, but that's a risk he takes.

2) Enforce the 3.5 times rule, Joe can't buy, and is forced to rent. Professional investor's buy, and make money off Joe.

If you were the goverment, what would you do?

Edited by BandWagon

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Fifteen years ago a low interest rate environment was a dream.

Rates were around 12%.

I think it's quite nice living in a low inflation, low rate world.

As a politician, in a country where 70% of the population own their own homes, would you talk about house prices coming down?

You wouldn't be a politician very long.

Edited by BandWagon

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was it in switzerland ?

that they have told people this is exactly what will happen

it should be gordon browns job to tell us

so what if he loses his job he wont be missed

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I think this one of those things where it's just too late now.

If only they'd enforced this restriction a few years ago (and restricted btl lending) we'd probably be fine now.

Also when the mortgage markets were liberalised to take female earnings into account if only they'd kept the joint earnings limit low!

Too late now, a clampdown would be electoral suicide at this point.

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Now what do you guys think is fair?

Increase interest rates to sensible levels.

The whole problem is caused by artificially low interest rates: if they weren't so low, then most 'investors' wouldn't be able to afford to buy the houses for stupid amounts of money either.

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So there is more news today of lenders relaxing the traditional income multiples, and effectively allowing people to borrow more, on the basis of "affordability".

Now the first thing that comes to mind is that if interest rates go up to closer to their average, then a debt that is affordable today will be unaffordable tomorrow, and people that borrow too much today, and hence inflate house prices, will be "punished" in the future.

But I worry: At the moment the current climate seems to be one in which as soon as the high street feels any pain through drops in sales, interest rates go down, or at least are not put up as rising inflation suggests they should be. What if the same keeps on happening? What if in the future interest rates should go up for some reason, but the armies of people who have borrowed now, and who would have unaffordable loans if rates rose, mean that the bank can't raise, beacause pain would occur for retailers and the wider economy? What if so many people get locked into this low rate, loans-on-affordability-basis that sheer weight of numbers means they are forever favoured, for fear of inflicting pain on the economy?

By the way, I hope this doesn't happen. I'm just worried that it is a possibility. Any thoughts?

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Increase interest rates to sensible levels.

The whole problem is caused by artificially low interest rates: if they weren't so low, then most 'investors' wouldn't be able to afford to buy the houses for stupid amounts of money either.

Drugs and drug addicts.

You can make them go cold turkey and embrace the pain.

You can slowly try and wean them off the drug.

You can keep supplying the drug.

Cold turkey is the quickest but most painful way (can actually kill)

Weaning off takes ages and ages and it is known for re-lapses

Keep supplying the drug is the easiest thing to do - its a problem you can deal with later isnt it?

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So there is more news today of lenders relaxing the traditional income multiples, and effectively allowing people to borrow more, on the basis of "affordability".

Now the first thing that comes to mind is that if interest rates go up to closer to their average, then a debt that is affordable today will be unaffordable tomorrow, and people that borrow too much today, and hence inflate house prices, will be "punished" in the future.

But I worry: At the moment the current climate seems to be one in which as soon as the high street feels any pain through drops in sales, interest rates go down, or at least are not put up as rising inflation suggests they should be. What if the same keeps on happening? What if in the future interest rates should go up for some reason, but the armies of people who have borrowed now, and who would have unaffordable loans if rates rose, mean that the bank can't raise, beacause pain would occur for retailers and the wider economy? What if so many people get locked into this low rate, loans-on-affordability-basis that sheer weight of numbers means they are forever favoured, for fear of inflicting pain on the economy?

By the way, I hope this doesn't happen. I'm just worried that it is a possibility. Any thoughts?

Firstly , dont worry about things you have no control over.

Secondly it is not different this time.

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About a year ago Prof Charles Bean (BOE) said that he thought house prices in the UK would come back to about 4 times average earnings.

That means about a 30% fall from where they are now.

Is this the price to pay for low interest rates?

Higher historical house prices?

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The UK is not the Soviet Union. If lenders are willing to lend at 6 or 7 times the income let them do so. This is a free country.

The real problem is that standard measures of inflation are no longer capturing the change in purchasing power (the China effect?).

Asset bubbles appeared everywhere and borrowing levels are out of control. The BOE is probably not as independent as they want us to believe or alternatively it is totally incompetent (isn't their mandate/goal to maintain financial stability?)

Just sit down and wait, prices will converge back to 3.5x and they will do so by crashing (forget soft landings)...

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was it in switzerland ?

that they have told people this is exactly what will happen

it should be gordon browns job to tell us

so what if he loses his job he wont be missed

I think there is more chance of finding Elvis on the moon than there is of Gordon Brown telling us that house prices need to come down.

Mervyn King did the right thing (and he took a big risk) by telling people last year that there was the risk of falling prices.

The government should have said the same thing about 5 years ago.

Edited by BandWagon

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The UK is not the Soviet Union. If lenders are willing to lend at 6 or 7 times the income let them do so.

Sure, provided the government let the banks go bust when the borrowers can't pay back the loans. Currently they're in a no-lose position: income if people keep paying interest, and a bail-out if they go bust.

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I have heard an economist saying that the natural rate of interest for the UK is around 5 to 6%.

So I would expect property to yield gross 7% to 8%, in the example of Joe this would mean the property would cost between £180k and £200k.

Where would you guys like to see interest rates?

Edited by BandWagon

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This has been raised many times on HPC, that historically the earnings ratio in the UK is around 3.5 times salary. Higher in London, lower up North.

So it has been suggested that if the government could restrict borrowing to this level (ie proof of income from Inland Revenue). This would stop Joe Public getting himself into the brown stuff.

However it's not very fair in a low interest rate environment:

Joe Soap earns £40k, and rents a London flat worth £240k.Six times gross salary.

Rent costs £1200pm, £14400 a year.

So the place is generating a 6% gross rental yield.

Now Joe can get a mortgage at 4.75%, so it's going to cost him 11400k a year to buy (IO mortgage).

Now currently Joe can go to a mortgage company and borrow 6 times earnings.

By doing this he can save himself £3000 a year.

He has to do the maintenance, but he's quite handy and doesn't mind the odd bit of painting.

Now what do you guys think is fair?

1) Allow Joe to buy the place, save himself some cash each month, and he's happy knowing it's "his" place. It may fall in value, but that's a risk he takes.

2) Enforce the 3.5 times rule, Joe can't buy, and is forced to rent. Professional investor's buy, and make money off Joe.

If you were the goverment, what would you do?

Simply put.

Interest rates fluctuate.

A stable economy is interest rates at double inflation.

i.e 3% inflation and 6% interest rates.

this means that it is still affordable to borrow and still makes sense to save.

Low interest rates encourage more borrowing then the economy can afford and less saving then it needs.

High interest rates mean that savings are good, but big purchases such as houses etc can not be afforded.

Prices in the housing market are reflected by affordability.

the intrinsic cost of building a house is very low.

When you see that the affordable houses will cost £60,000 it should be remebered that a four bed detached costs less than that to build.

Essentially...

Interest rates will change. They have been kept low to drag the economy through .com burst 911 and then the iraq war.. That has been admitted by Gordon Brown.

They will go up.

and the head of the bank of England said that "House Prices are a matter of oppinion, but that debt is real"

The BTL Landlords either need to borrow the money.

and at todays prices they are loosing money to rent.

or if they invest their own.. they get more back from a high interest bank account

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gordon brown was quick to tell people {no more boom n bust }

i think it would be appropriate for him to admit where we are now

dont you think?

imo he created it

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once a few familes get battered having signed up 10x salary for the smallest terrace in town.

after a few horror stories people might LEARN not to over stretch themselves.

but the hyper inflation has been mostly due to BTL.

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gordon brown was quick to tell people {no more boom n bust }

i think it would be appropriate for him to admit where we are now

dont you think?

imo he created it

I don't think GB created it,it's an international phenomenon....what GB FAILED to do was curtail it.He(wrongly) thought it was a way of avoiding a recession...instead what it did was postpone the inevitable....and make the consequences worse for joe public when it bites.

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I'm beginning to think that the exit p/e ratio of this bubble will be significantly higher than the 3.2 of the last one and down the new post-1992 interest rate environment. I did a few rough sums last week and got this graph: blue, HBOS p/e; red, my modelled p/e; green, the baseline price p* calculated assuming that 20% of gross earnings is converted into borrowing using the historical earnings and IR data, with an extra factor to account for the loan:price ratio. The difference between the blue and green lines is the speculative froth element – patched with a crude Gaussian fit.

dqrofc.jpg

I admit that I’ve not put much effort into tuning this, so it’s a bit rough, but the central idea seems to stack up. I’ve continued the model out to 2010 with earnings growth at 4% pa (maybe a high?) and current IRs. The pre-1990 mismatch comes from ignoring the tax changes.

Initial conclusions: this bubble is only about 60% of the size of previous one (pre-inflated by the tax change); and the exit p/e will be higher at around 3.7 to 4.0;

Edited by spline

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I believe it was GB who commissioned the Barker report into the housing shortage in the UK.

Recommendations were to ease planning restrictions and to increase the housing supply. However, despite this report, we know that the housing shortage does not account for the price rises we have seen.

The housing market has more the elements of a speculative bubble.

Experience tells us that goverment interference usually makes things worse.

Perhaps we should just leave this bubble to market forces?

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Initial conclusions: this bubble is only about 60% of the size of previous one (pre-inflated by the tax change);

Surely it is the other way round; the last bubble was 60% the size of this one? A "bubble" purchase made more sense in the 80's, because the government bunged home-owners a load of wedge in the form of dual-MIRAS and LAPRAS; no such handouts are available to homeowners now.

And what do you mean by 'the loan:price ratio

I suspect he means loan-to-value ratio (ie the loan as a percentage of the property's appraised value):

http://www.cml.org.uk/servlet/dycon/zt-cml...l_Table-PR2.xls

See the "FTB's percent advance" and "Movers percent advance" columns.

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This has been raised many times on HPC, that historically the earnings ratio in the UK is around 3.5 times salary. Higher in London, lower up North.

So it has been suggested that if the government could restrict borrowing to this level (ie proof of income from Inland Revenue). This would stop Joe Public getting himself into the brown stuff.

However it's not very fair in a low interest rate environment:

Joe Soap earns £40k, and rents a London flat worth £240k.Six times gross salary.

Rent costs £1200pm, £14400 a year.

So the place is generating a 6% gross rental yield.

Now Joe can get a mortgage at 4.75%, so it's going to cost him 11400k a year to buy (IO mortgage).

Now currently Joe can go to a mortgage company and borrow 6 times earnings.

By doing this he can save himself £3000 a year.

He has to do the maintenance, but he's quite handy and doesn't mind the odd bit of painting.

Now what do you guys think is fair?

1) Allow Joe to buy the place, save himself some cash each month, and he's happy knowing it's "his" place. It may fall in value, but that's a risk he takes.

2) Enforce the 3.5 times rule, Joe can't buy, and is forced to rent. Professional investor's buy, and make money off Joe.

If you were the goverment, what would you do?

restricting lending to owner occupiers would have to accompanied by restrictions on lending to BTL and/or changes in tenancy laws generally

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  • 302 Brexit, House prices and Summer 2020

    1. 1. Including the effects Brexit, where do you think average UK house prices will be relative to now in June 2020?


      • down 5% +
      • down 2.5%
      • Even
      • up 2.5%
      • up 5%



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