Logic Error: The average earner can’t afford the average property…
Posted by markharrison on August 5, 2007
There’s a “logical error” going round the Internet at the moment.
It runs as follows:
- The average family can’t afford an average house, therefore property is overpriced
The calculation then typically looks at the average income in an area, and compares it with the average selling price of property, and the mortgage rate. The conclusion is then that the average income couldn’t cover the average mortgage.
This is correct so far.
The next conclusion is that, therefore, property is overpriced.
Nope. This is a logic error!
The problem that the calculation is making is that the “average family” looking to buy the “average property” has ZERO equity. Well, by definition, the average family, living in an average property has an AVERAGE amount of equity.
Consider the following cases – the property prices are based on those near me, the names of people are fictional:
- The average three bed semi-detached costs £245,000
- The average two bed mid-terrace costs £190,000
- Ten years ago, the average two bed mid-terrace cost about £90,000
- Consider Alice, who with her partner Andy earn a healthy £40,000 between them. Suppose that they can scrape together £25,000 for a 10% mortgage. This means they’d need to find a mortgage lender will to lend them £220,000 – or just over 5.5 times their joint earnings. A mortgage payment of about £1,100 a month would result, out of an after tax take-home of about £2,300. Still leaves over a grand a month for food bills and running a car.
- Now consider Bobby and Belinda, who only earn £20,000 between them. Not only is coming up with £25,000 going to be harder, but the mortgage of £220,000 would be over 11 times their joint earnings, so it’s a no-no.
- But what about Christine and Colin. They only earn £20,000 as well. However, 10 years ago, they moved into a local two-bed, and put down a £10,000 deposit. Over the last ten years, that £10,000 equity has grown to £120,000. So their mortgage need is £125,000. OK, it’s still about 6 times income, but it’s a lower loan-to-value, so they’ll get a better mortgage deal than Alice and Andy. Their mortgage payment would be about £625 a month, out of a take home of about £1,150.
The net result is that, by starting a working up the ladder, Christine and Colin can afford a home as big as Alice and Andy, for about 50% of their after-tax payments as a mortgage.
Now, you may well argue that 50% of take home is far too much, but that’s a completely different argument.
By the way, average income here is nearer the £40,000 mark than the £20,000, so when you take into account average deposits, most people locally AREN’T having to stretch like Alice and Andy.
The names are made up, but the principle isn’t – the first flat I bought (to live in) was a 450 sq. ft. studio flat. Not the house my family and I are living in 12 years later!