There has been a lot of news recently suggesting that property is becoming increasingly affordable.
The Bank of Scotland said recently that Scotland has the most affordable housing in the UK. Here’s their press release on the subject: Scotland has the UK’s most affordable housing
A time to buy?
The issue is more than academic. If property is affordable now, then it’s probably a good time to buy. If you think homes are still over-priced, then you would delay your purchase until later.
So, which is it?
Measures of affordability
There are two common measures of affordability; the price earnings ratio – the average house price relative to average income – and the ratio of mortgage payments to income -how much of someone’s income goes to paying the mortgage.
The trouble is that, right now, these two tell you completely different things (see chart). One says property is a bargain, the other says not. Which begs the question, which measure should you be looking at?
I think the better measure – and arguably the better predictor of house prices – is mortgage interest as a proportion of income. Here’s why (and apologies if this is heavy going).
To test which indicator is a better measure of affordability, you need to look at their past performance. The graph on the right shows how these two measures changed over the last two recessions.
The house price ratio (in blue – house prices as a multiple of average income) broadly mirrors house prices since a fall in the ratio happens as a result of a fall in house prices, rather than a fall in income.
Note that prices continue to fall when the red line (the cost of mortgages relative to incomes) is high, but stablise when it falls. Note too that as the house price ratio broke through its previous peak in 2003, mortgage costs remained relatively low.
Finally, note that house prices stabilised around 2010 despite being well above their previous peak (as measured by the house price ratio) as mortgage costs fell.
Mortgage costs more important than price
In short, it looks very like mortgage costs are a more important influence on the market.
The key reason why prices rose above their previous peak is that falling interest rates and intense competition between mortgage lenders meant that borrowing costs fell sharply. You could borrow roughly twice as much in 2004 as you could have done in 1999 for the same monthly cost. And they have remained higher than the price earnings ratio would suggest they should be because mortgage costs have fallen once again.
All of this suggests that it is really the running costs of property, not the multiple of our income that the purchase price represents, that is the better measure of affordability.
A quick thought experiment
If you doubt that, maybe a thought experiment might help. If you could buy a £1 million home – complete with all the luxuries that that implies – with a 100 per cent mortgage and the monthly mortgage cost (including capital repayments) was £602 (the average rent in Glasgow for a two bed flat according to a recent study for Glasgow Housing Association), would you buy it? I would and I’m guessing that I’m not alone. In short, it’s not how much we borrow, it’s how much it costs us to repay it that matters.
That’s why I suspect that the ratio of mortgage payments to income is a better guide to market conditions than a ratio of price to income.
Property looks affordable
On that basis, the current cost of a mortgage makes property look pretty affordable. Mortgage costs as a proportion of income (the red line) are down to levels last seen in 2003.
Ah, but what happens when interest rates rise – as they surely will?
That is properly the subject for another post. Congratulations if you have got this far. But suffice it to say that interest rates were broadly in a range between three and five per cent for over 250 years between 1694 and 1961. The interest rates we experienced between 1960 and 2000 were a response to a period of exceptionally high inflation and an ill-advised attempt to support the pound. No doubt interest rates will rise, and possibly quite soon. But whether they will get back to the levels we saw in the 40 years to 2000 is another matter.