Can the “Average Person” afford the “Average House” in the UK?
I purchased my first property back in 2007. I had finished university and wanted to buy a flat in a good location near to where I worked. It was a little expensive for our budget, but hey, prices always went up, right?
Unfortunately, my naivety cost me on this occasion! I did not exactly buy at the best time. In fact, I bought…
Since the end of this graph, house prices have once again increased in the UK in general (note: please see my usual rant about this increase being mainly pushed by London, which is NOT the UK).
However, real wages in the UK have decreased over this time.
You also often hear people saying “I can’t afford to get on the property ladder”, “property is too expensive”, etc. The government has even introduced the controversial help-to-buy scheme to address this point.
This got me thinking about averages. It doesn’t take a lot – I love thinking about averages. However, it made me ponder the following question:
Can the average person afford to buy the average property – short answer
Short answer, no.
For the average first time buyer to complete their purchase, they would need to:
- aggressively save for 6.5 years to afford the deposit
- be at the dangerous end of the “affordability” spectrum with the mortgage provider
- pay almost 50% of their take home pay against their mortgage
Can the average person afford to buy the average property – long answer
How did we arrive at this conclusion?
Well, to answer this question, we clearly need to define some averages. Firstly, we need to determine the “average person”. Given that we are looking at first time buyers, I will assume that the average person is between 25 and 35 years old. For this person, here are some figures which we will need to use:
- Average gross personal income: as per the April 2013 ONS wage figures (the latest figures available), the average annual wage in the UK (for the age band 22-39) was £21,737.
- Average net household income: as an estimate, we shall take 150% of that figure to represent the average household income for this age range => £32,606.
- Based on a calculator using current UK tax rules (and a 10% contribution to your pension fund), this gives take home pay of £22,383.
- Average price of a first time home: as per the December 2013 ONS house price index, the average price of a home purchased by a first time buyer was £189,000.
Assumptions regarding house prices, savings, inflation and wages
Before we start, we will also need to make some assumptions.
Firstly, we will imagine that we can save any money tax free in an ISA account at 3% interest.
House prices whilst we save shall also increase at 3% per year.
This is a prudent estimate as, in reality, house price increases typically exceed the rates available for cash savings.
Secondly, we shall assume that wages shall increase in line with inflation.
Therefore, we can ignore the impact of these factors on our calculations.
Deposit – Affordability
To obtain a sensible LTV rate of 80% on the average property, we will need a deposit of £37,800. If we add agents’ costs, solicitors’ fees, stamp duty, etc, we would need an estimated £43,000 saved for a deposit.
Let’s assume that this household are excellent savers and can put away 30% of their net income every month towards their deposit. In reality, I suspect that the “average person” saves a much lower percentage of their income.
This would mean that we need to save for:
6.4 years
Mortgage – Bank Affordability
The general rule for banks is that a mortgage can be provided for 4-5 times your gross salary. Most financial gurus will suggest that you should be at the bottom of this range or, if possible, well below this range.
Based on this calculation, the average household earning £32,606 gross can afford a mortgage between £130,000 and £163,000.
An 80% LTV mortgage on the average property would be £151,200. This would fall towards the top end of this bracket – 4.63 times the household salary.
Mortgage – Actual Affordability
However, it is generally accepted amongst personal finance geeks (like myself) that you should be on the low end, if not below, the 4 times figure.
Let’s have a look at the actual repayments on the mortgage to see if they are affordable.
If we are looking at a 5 year fixed rate, a quick glance at a mortgage comparison site shows:
So, over 20 years (we would advise the average person to pay over 20 years or less if they are trying to build long-term wealth), the average monthly payments on the cheapest deal would be £876.12. However, this is the monthly payment during the 5 year fixed period.If we took the average monthly payment over the life of the mortgage (the 5 year intro plus the remaining 15 years), the monthly payment would be £903.35.
The average household is bringing in £22,383 per year, or £1865 per month.
Almost all personal finance gurus suggest that you should spend no more 25% of your take home pay on your mortgage payments.
The average person, in this example, is paying almost double that at 48%.
The average person cannot afford the average first time house
For the average first time buyer to complete their purchase, they would need to:
- aggressively save for 6.5 years to afford the deposit
- be at the dangerous end of the “affordability” spectrum with the mortgage provider
- pay almost 50% of their take home pay against their mortgage
What about rising interest rates?
This is where things really might go badly!!
The above calculations are performed on the assumption that for 15 years after the fixed rate period, mortgage interest rates would remain at 3.9% APR.
Quite simply, they won’t – see the final section of this article to see why interest rates will rise.
What would happen if base interest rates rise each year so that they are back at their long term average by 2020 (5%)? They then remain at this level for the remainder of the term of the mortgage.
Well, our average repayment would be £1,102 per month. This would represent almost 60% of the average household’s take home pay.
If the average person was to do this, there is very little chance that they would be able to save anything going into the future and would leave themselves in a very precarious position financially.
What should the average person do?
We like to provide solutions as well as problems.
There is only one real solution and it is something that you should remember in every aspect of life (not just personal finance):
- Don’t be average
Simple.
In this situation, you should be doing two things:
- Buy a house for way under the UK average price. There are plenty of suitable properties at much more affordable prices that £189,000. It just takes a lot of research (and some sacrifice on size and location if you live in London).
- Earn more money. This sounds tough, but even an extra £20 per week by doing something a trivial as babysitting would mean an extra £1,000 a year in income. This one tiny change would bring down your monthly percentage of income spent on your mortgage in our example from 48% to 44%.
What do you guys think? Is it fair that the average person cannot afford the average household? Do banks have any obligation to reduce their “5 times income mortgages” when this could mean that the average person has to pay 50% of their take home pay on their mortgage?
Housing prices are fairly cheap in the U.S., but there are definitely places where the average person can barely buy a shack or tiny apartment. I think that high housing prices should be an incentive for people to move out of the big cities, personally. I would hate paying anything over 200-30% of my income toward my home.
This is the same as in Canada. Houses are NOT cheap, and something an American would consider average in the U.S. might cost $150 – $300K there, but is $800K – $1 million here. It’s insane.
No one can afford to buy a house without help or going into massive debt.
Australia is the same, crazily overpriced. Most live in the city and the houses are simply not affordable. I know many families who live with more than one family in the home to be able to afford to live.
Property ownership is still so important to people in the UK, however renting for life may have to become a more accepted option!
“If you tell a big enough lie and tell it frequently enough, it will be believed.”
Governments, banks, the media and estate agents have colluded in trying to convince the UK public that overpriced houses are now the norm, despite the fact that housing is unaffordable as you’ve illustrated. The reason the whole sorry system continues is that people believe this bullsh*t.
We need to organise a buyers strike. If we don’t buy then the whole system grinds to a halt.
There may be signs that buyers are beginning to rethink the crippling costs of this misguided endeavour, as prices are finally falling in London.