A REMARKABLE TRUTH at the heart of our dysfunctional housing market is that mortgage affordability is little better now than it was at the height of our property bubble.
There is the widespread belief that the decrease in Irish house prices since the peak of the bubble has made purchasing a home much more affordable. Perhaps if you are a cash buyer it has, but for those who need to finance a property purchase with a mortgage and whose income is from a wage, for them the increases in mortgage costs and decreases in take home pay mean affordability has not improved much, if at all. And as house prices rise again affordability will quickly become worse than it was even at the peak of the housing bubble.
Let’s look at the example of a single first time buyer earning €50,000 and examine the scenario where they take out a typical 92% mortgage to buy a home, comparing 2008 to 2014. For our example we’ll examine a property purchased in 2008 for €300,000 (€24,000 deposit, €276,000 mortgage) and assume it costs €161,100 to buy the same property today (€12,888 deposit, €148,212 mortgage), based on the latest CSO estimate of 46.3% for the decline from the peak of the bubble. This is undoubtedly conservative as the properties people actually want to buy in many cases won’t have dropped this much.
Take home pay has declined
Based on CSO wage figures we’ll assume a 2% drop in a private sector salary since 2008, with a similar overall decline in public sector pay once the two rounds of pay cuts are balanced by increments. Although there have been increases in income tax and PRSI, the real story regarding take home pay is the huge chunk that the Universal Social Charge (USC) claims – well over 5% of total salary in our example. For a public sector worker the same again and more is taken by the Pension Related Deduction (PRD) giving a 17.5% reduction in take home pay for a public employee since 2008 and a 9.7% decline for a private employee. Mortgages have to be repaid from after tax income so this decline has a direct impact on the affordability of financing a purchase.
We’ll assume the 2008 purchaser is on an ECB+1% tracker (giving a total rate of 3.5% in 2008) and that the 2014 purchaser is on a 5% standard variable rate mortgage. In both cases we’ll use a term of 30 years. In 2008 the purchaser benefited from sizeable mortgage interest relief (gone for new buyers) while the 2014 purchaser gets to include property tax (at 0.18%) in their annual costs. In 2008, the annual costs came to €13,000, versus €9,930 for the 2014 purchaser, almost 24% less. Significantly cheaper you might say, but let’s look at those costs in terms of take home pay (which is the metric banks use to assess mortgage affordability).
The real cost
As a fraction of take home pay the cost of financing this purchase has only declined from 34% in 2008 to 31.5% for a public sector worker and 29% for a private sector worker today. In real terms its only 2.5% to 5% cheaper to service a mortgage today on the same house as it was at the peak of the bubble. This difference is not irrelevant, but it is modest, and every day house prices rise its becomes smaller still.
And, of course, any mortgage payment has to come from a net income that is much smaller than in 2008 and which also has to pay many other expenses that have risen rapidly (eg, health insurance and car related expenses to name two obvious ones), meaning overall disposable income has been seriously squeezed, all of which makes financing a mortgage even harder. Other examples with different salaries and house prices show the same pattern (you can see those and the detailed figures for the example discussed here on NowOrSoon.com).
As house prices now seem to be rising rapidly again we will soon see a situation where mortgage affordability for a current purchase is actually worse than at the peak of the housing madness during the Celtic Tiger years. For many popular residential areas in Dublin, we have probably already crossed that point and mortgage backed would-be-buyers are being priced out of those markets.
What about the 2008 purchaser now?
It’s also worth looking at the cost to a 2008 purchaser of their mortgage today. With the slashing of ECB interest rates to 0.15% their tracker repayments have declined by over a quarter. The State also increased mortgage interest relief for this cohort (up to 30% from the 20% level when they bought), though with less interest being paid the absolute amount of relief has gradually declined. So their costs have plummeted – such is the value of a tracker (and the State support). Despite suffering the same tax rises, new deductions and property tax along with everyone else, the affordability of their mortgage in real terms has actually increased, by 1.5% for a public employee and by over 4% for a private one.
And even with the big decline in house prices and hence the much lower mortgage being taken out today, in real terms there isn’t really any difference in the cost right now between a 2008 and a 2014 purchaser – its just as expensive to service a mortgage on a house bought today as it is to service the negative equity mortgage taken out on that house at the peak of the bubble.
This is why cash buyers dominate the market, as they can use their capital to immediately exploit the benefit of the reduced asset price. They don’t need to use financing that has ever-increasing costs, and that needs to be serviced with ever-declining take home pay. Unfortunately, if left unchecked this will lead to an ongoing concentration of wealth into the hands of those who already have capital, with ordinary workers who are relying on their wages priced out of the housing market. This will lead to greater inequality long term. Whether consciously or not this is the direction of Government policy.
But I thought ‘surging’ house prices were a good thing?
Maybe for estate agents and newspaper property supplements they are, but for most citizens and the country they are not. The numbers above show financing a property purchase today is only marginally more affordable than it was at the very height of the bubble. If prices rise in double digits unchecked, a mortgage will quickly become a lot less affordable than it was even in the craziest days of the boom, making home ownership an impossibility for many.
For the country as a whole, this high cost of home buying (combined with the recent rapid increases in rents) has a hugely negative impact on our competitiveness – it looks likely that the competitiveness gains of recent years will be quickly washed away by rising accommodation costs, if they haven’t been already. Increased housing costs also ensure that any boost in consumer spending is unlikely as disposable income goes on rising rents and mortgage costs. The inconsistency of the Government in talking up the ‘surge’ in housing costs while also claiming to be serious about competitiveness and consumer spending is stark, but like much in our property market is rarely commented on.
The numbers discussed here show that, despite the hype around the fall in property prices, for potential homebuyers it’s only a few percent cheaper to service a mortgage drawn down now than it was at the peak of the boom. And remember this is despite the big drop in the price of the house – we’re talking about the same house, not the same price. And although there has been a heavy focus on the financial pressure negative equity mortgage holders are under, today’s servicing costs for new mortgages on equivalent houses are no cheaper than what those in negative equity are currently paying for their larger mortgage from the boom era.
While there is no single silver-bullet solution to this lack of affordability, its existence should at least become part of the debate. The fact that mortgage affordability is little better now than it was at the height of our property bubble is a reality we can no longer ignore.