Generation rent to generation buy

Young people are finding it increasingly difficult to get a foothold on the property ladder. Home-ownership rates for those aged between 25 and 34 fell from 65% in 1996 to 27% in 2016. In an attempt to counter this, the government has recently announced plans to offer 5% deposit mortgages to help first-time buyers onto the property ladder,  to ‘create two million more homeowners’ and ‘turn generation rent into generation buy’. The real effects of this policy are open to debate.

The average deposit required in the pre-COVID-19 mortgage market was 46,000 GBP.  Young people struggle to save such a large amount with their finances being seriously depleted by stagnant salaries, high rental costs, low-interest rates and poor returns on low-risk assets such as government bonds and defensive equities. Thus, deposits take many years to accumulate. According to Nationwide, it takes nine years to save for a 20% deposit. Offering low deposit mortgages would reduce the saving period, reduce the disincentive and therefore increase youth home-ownership rates.

Moreover, in pre-pandemic 2020, low deposit mortgages were widely available: 750 deals required a 10% deposit, whilst 385 deals needed a 5% deposit. The market thus seems prepared to offer such mortgages without state incentives. However, the post- COVID-19 market is different. Similar to the 2008 recession, to reduce credit risk and conserve cash to deal with the expected waves of loan losses, nearly all low deposit mortgages have been withdrawn. After the financial crisis, gross mortgage lending was stagnant from 2009 to 2012, afterward only growing gradually. Therefore, low deposit mortgages will remain unavailable for the foreseeable future, worsening the situation for strained first-time buyers. In this case, government intervention to increase provision of low deposit mortgages could be highly beneficial.

However, the question of how low deposit mortgages will be provided is problematic. One potential method is for the government to act as a guarantor, decreasing the risk to lenders, and incentivising them to offer more mortgages. Last year there were 335,000 first-time buyers. If they all contributed a 5% deposit and the government guaranteed the remaining 15% required for a 20% deposit, then with the average house price being 235,000 GBP, the government would have a 35,250 GBP liability per house. 11.7 billion GBP in total liability would be added to the government’s balance sheet each year. In a severe crisis, default rates could rise to 5%, increasing the total cost to 600 million GBP to banks for each year the scheme was operational.

Furthermore, banks may be severely impacted. If 95% mortgages became standard, the size of deposits would fall across the market. Some lenders may seek to gain the first-mover advantage and undercut their rivals by offering 100% mortgages. Some may go even further and offer 100%+ mortgages. The significant increase in the risk of negative equity is highly detrimental to homeowners, as the total borrowing secured against first homes owners outweighs its value, increasing their personal debt. More importantly, the average risk of bank assets and the associated probability of bank failure and its devastating macroeconomic consequences rises substantially. Though in the short term prices there may be a house price boom, the market would eventually correct itself, and these risks would materialise.

Overall the intentions behind the policy are admirable, and the poor affordability and low youth home-ownership rates are both justifiable reasons for intervention. However, the unnecessary burden to the strained taxpayer and increase in the risk of bank failure outweigh the potential benefits. Additionally, the benefits are restricted to a small group of people, whilst the costs are a potential burden to all.

 

By Jon Garner

Sector Head: Jackson Philips

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