Why has home ownership collapsed?

A simple question with a not-so-obvious answer.

Last week the IFS produced a report that documented the dramatic collapse in home ownership among young adults. The report concludes that rapid house price growth since 1996 was the cause. But this blog argues that the main driver was actually the sudden change in credit conditions for first-time buyers in the wake of the financial crisis. This explanation points to a very different set of policy options if we want to recover the high home owenership rates of the early 2000s.

In its report, the IFS documents how the home ownership rate among UK-born 25-to-34 year old dropped dramatically from a peak of about 58% in 2002 to around 39% in 2016. The authors pin the blame squarely on rising house prices relative to incomes, citing a 152% increase in real house prices in the 20 years after 1995–96 compared to a meager 22% real terms rise in household incomes for young people.

They conclude that the fall in home ownership is an open and shut case that conforms with common sense: “The increase in house prices relative to family incomes fully explains the fall in home ownership for young adults.”

But does it? Two observations should make us worry about that conclusion.

1. Home ownership fell most while prices were falling

First, the timing of the fall in home ownership doesn’t coincide particularly well with the period of rising prices nationally. In fact, three quarters of the fall in home ownership occurred after house prices had begun to fall. Among the young UK-born population examined in the report, home ownership drifted down by about five percentage points from its peak in 2002 to the eve of the financial crisis in 2007, a period when house price growth was going gangbusters. But it then collapsed by a further 15 percentage points over the following seven years, when house prices dropped by around 25% in real terms (see charts — annotations my own).

2. Home ownership fell similarly in all regions despite divergent price trends

Second, the fall in home ownership after the crash was similar in all regions of the UK despite widely differing trends in house prices. The chart below uses the UK House Price Index from the Land Registry, and home ownership data from the Labour Force Survey. The years from 2001Q4 to 2007Q4 — the pre-crisis red dots — saw phenomenal cumulative house price increases across all regions, while home ownership fell only marginally in most areas. It even increased in the two regions exhibiting greatest price growth.

In the post-crisis period from 2007Q4 to 2016Q4 (blue dots), house prices in the north fell by around 20% in real terms while London prices grew by 29%, yet home ownership rates fell sharply everywhere. So it’s hard to square these regional trends with the idea that house price growth explains the sudden drop in home ownership.

Sources: UK HPI adjusted by CPI, home ownership rates from LFS Q4 of the respective years.

The major cause: a first-time buyer mortgage drought

A look at first-time buyer mortgage data tells a much more compelling story for why home ownership rates collapsed. Obviously the overwhelming majority of FTBs need a mortgage. If high prices were increasingly preventing them from accessing mortgages in the run up to the crisis, we might expect to see the number of new FTB mortgages drifting downwards in the years up to 2007. There is some evidence of this in the early 2000s, but in the five years up to 2007 the issuance of FTB mortgages was pretty constant at around 370,000 per year. In 2008 that number suddenly almost halved, to 192,000, and didn’t really recover for the next six years. Only in 2017 did it regain something close to pre-crisis levels.

Source: CML, First-time buyers

Such a discontinuous change in lending just as the crisis struck doesn’t fit with the idea that high house prices were primarily to blame. Rather it seems like the financial crisis — and possibly subsequent regulatory changes via the Mortgage Market Review and limits on high loan-to-income lending — pulled the plug on new home owners.

Indeed, had lending to FTBs continued at it’s 2003–07 average from 2008, there would have been around one million more home owners by 2013, and the national home ownership rate would have remained around its 2007 level.

Other mortgage data for FTBs traces out the impact of the crisis on would-be home owners. From 2008, the deposits of those able to secure a mortgage suddenly jumped as a proportion of the price of the houses they were buying, even as house prices tanked. This happened because lenders retreated from risky, high-LTV lending, with 95% LTV products all but disappearing for good and even 90% LTVs becoming much more scarce until recently. Even by 2015, the median LTV had not returned to its 90% norm before the crisis.

In practical terms this suggests that, to buy a house in the years after 2008, the median first-time buyer had to have a much bigger deposit in absolute terms than was needed before that point, despite prices in most regions being lower.

Source: CML

Nor was it just the quantity of lending to FTBs that was restricted — the relative price of their mortgages jumped too. The chart below shows the percentage points spread between the mortgage rates available to 75% LTV borrowers, and those available to 90% or 95% LTV borrowers, from the Bank of England. Unfortunately it’s a broken time series since 95% LTVs disappeared from the market for a period. But what’s clear is that, up to the crisis, FTBs borrowed at very similar cost to those with a more substantial chunk of equity. But from 2008 their mortgage rates jumped way above those for people taking out 75% LTV products and, despite improving, remain significantly higher even now.

Source: Bank of England, IUM2WTL, IUMB482, IUMBV34

A jump in relative borrowing costs and deposit requirements were therefore the factors that accompanied the choking off of lending to FTBs after 2008. Rightly or wrongly, this decisive turn against relatively risky FTB mortgage lending had a huge impact on the home ownership rate. This, far more than high house prices, is the reason for its collapse.

The cyclical upswing, combined with some assistance from policy — in the form of the Help to Buy schemes and Funding for Lending — caused a revival in lending to FTBs from 2013. But with more stringent affordability checks for borrowers now in place, and caps on high loan-to-income lending since 2014, it seems unlikely that FTB mortgage issuance will rise sufficiently to recover 2003 levels of home ownership, even in regions where prices are now much lower than they were in 2007.

Policy implications

None of this is to say price levels are irrelevant to home ownership. All else equal, lower prices would increase it by reducing the scale of deposit required to buy. The point is that the mortgage market was a far greater cause of the recent collapse. That matters because an effective policy solution to raise home ownership depends on correctly identifying the cause of that collapse.

If high house prices were the major driver, then the only real ‘solution’ would be to hope for higher real interest rates to bear down on prices, since even substantially higher rates of supply will have little impact on prices, as Simon recently explained.

But once we realise that the home ownership rate depends critically on the availability and cost of mortgages for FTBs relative to those for other would-be buyers (implicitly buy-to-let), different policy options emerge. The good news is there are three broad options. The bad news is that none of them are politically easy.

  • Privatise the risk again. One option is to end the limits on high loan-to-income loans, and relax mortgage affordability tests. That might allow the average would-be home owner to buy sooner, driving up home ownership. But in light of the financial crisis, those limits and constraints have been introduced for good reasons and it would be a bold politician who recommend allowing the banking sector to assume lots risk again as a way to push home ownership back up.
  • Publicly subsidise the risk (more). If you’re not too impressed with the private sector’s risk-management track record of late, an alternative way to raise home ownership would be to use taxpayers’ money to subsidise it. Re-introducing MIRAS (mortgage interest relief at source), the direct mortgage interest subsidy introduced in 1983 to boost home ownership and abolished in 2000, would be one option. Or we could extend George Osborne’s Help to Buy schemes — almost a covert version of MIRAS — where the taxpayer took on £12bn of contingent liabilities. For all its detractors, Help to Buy almost certainly helped to break the fall in home ownership.

Politicians of almost every stripe support the goal of raising home ownership. But rather than letting them peddle bogus solutions like increasing housing supply, we should ask them to clarify who they would have pay to make that happen. Or, of course, there is a third option:

  • Give up on achieving 70% home ownership. If neither of the above seem acceptable, then we may have to acknowledge that the 71% home ownership rate of the early 2000s is a thing of the past and accept that something nearer the current 63% is here to stay. If the private rented sector was more secure and attractive, might this be the most politically palatable choice?
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