Highly indebted first home buyers no threat to housing market stability

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Fewer people are making the transition from renters to first home buyers since the financial crisis but those that do are more financially stable than earlier cohorts.

This is the key finding of a report on first home buyers published by the Reserve Bank earlier this month. The ability of first home buyers to manage their mortgages, given the high cost of housing, has been a central concern of commentators worried about the stability of the housing market.

What the RBA research suggests is that we can stop worrying that first home buyers will start defaulting en masse at the first sign of trouble.

“While saving a deposit is a stretch, it is also a sign of financial discipline that is associated with fewer subsequent difficulties,” John Simon and Tahlee Stone say in their paper, The Property Ladder After the Financial Crisis.

“This contradicts the view that those who do manage to buy a first home, in the current environment of high house prices and high household debt levels, are taking on an inadvisable level of debt to do so.”

Concerns over the level of debt are often expressed by reference to the debt-to-income ratio, which has risen from around 100 per cent of household income in 2000 to around 160 per cent at the end of last year.

First home buyers typically have mortgages with higher loan-to-valuation ratios and higher debt servicing burdens.

Simon and Stone offer three reasons why the proportion of first home buyers has fallen since the financial crisis.

It is possible that the financial crisis changed household risk tolerance and behavior. Households may be more wary of taking on any new debt and this might be one explanation for declining rates of home ownership.

There are also some demographic factors that may be driving the decline in home ownership among younger Australian households. These include the trend towards later marriage and family formation, and an increase in single-adult households.

And the deposit requirement is an important barrier delaying transition into home ownership. Rising house prices have steadily raised the effective deposit requirement.

“Our results support the hypothesis that higher house prices have crowded out potential first home buyers from the market,” the report says.

“There is very little evidence of changing demographics over the 2000s and little evidence of the impact of increased risk aversion since the financial crisis. The age of becoming a couple household did not change between the two periods of the study.

“Households still have a similar desire to become home owners. Higher levels of renting are a refection of higher house prices.”

When they do get into the housing market, the debt-to-income ratio of first home buyers is substantially higher than that of all other indebted owner-occupiers. This reflects the fact that they are at the beginning of their loan life cycle. The median first home buyer debt-to-income ratio rose from 230 per cent in 2001 to 330 per cent in 2014.

Purchase prices have risen faster than income. The median price paid by first home buyers in the years from 2008 to 2014 was $387,000, which was almost $100,000 higher than the median price paid between 2001 and 2007. The median deposit rose by around $28,000 to close to $70,000 over the same period.

The debt servicing ratio rose from 20 per cent in the period from 2001 to 2007 to 26 per cent in the period 2008 to 2014.

Despite all this, households that became indebted first home buyers after 2007 appear to be paying down their mortgages and reducing their debt-to-income ratios at the same rate, or slightly faster, than households that took on mortgages before 2007.

Rates of amortisation are higher than those associated with required repayments.

Not only that, but the share of first home buyers that reported being either moderately or totally satisfied with their financial situation in the 2008 to 2014 period increased from 57 to 66 per cent, a higher increase than for other groups of indebted owner-occupiers and renters.

First home buyers in the 2008 to 2014 period are less likely to have ever reported being behind schedule on their loans or asking for financial help than the previous cohort.

“On balance, post-crisis first home buyers are more financially secure than their pre-crisis cohort, despite higher levels of debt. Although they are having to save more of their income for a deposit and are facing a higher debt servicing burden, we do not find evidence that first home buyers have taken on too much debt or more at-risk,” the report says.

A plausible explanation for this is that those first home byerss who are able to save enough to meet higher deposit requirements imposed by higher house prices are also less likely to experience subsequent financial difficulties after taking on a loan.

Higher deposit requirements are serving to restrict first home buying to more financially stable households. This is a de facto tightening of credit standards.

A factor that potentially confounds the findings is the small but growing share of first home buyers that receive financial assistance from family and friends. It is possible that first home buyers who receive help to meet the deposit requirement have less financial discipline than first home buyers who have saved the entire sum independently.

Around 23 per cent of households that received help with their loan received additional assistance in the years following their initial purchase, compared with 11 per cent for independent first home buyers.

The report says: “In one respect this is unsurprising. Parents willing and able to help their children are likely to continue doing so. It doesn’t necessarily follow that these households are more likely to default.

“However, first home buyers who received help are more likely to experience cashflow problems in the form of not being able to pay their utility bills or met their mortgage repayments due to a shortage of money.”

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