This is a thought experiment. It concerns two couples: the Austins and the Browns. As far as we are concerned, they have identical qualifications, identical jobs and identical tastes. So similar are these two pairs that they got married on the same day. On the Austins’ wedding day, the proud parents clubbed together and presented the happy couple with the deposit on a house. On the Browns’ wedding day, their proud parents clubbed together and presented the happy couple with a toaster.
On the strength of their earnings, backed by a healthy deposit, the Austins were able to get a 25 year mortgage on a house. On the strength of their earnings, but without a deposit, the Browns were not able to obtain a house, so they rented. By the sort of coincidence that is the essence of thought experiments, the Browns’ initial monthly rental payments were identical to the Austins’ mortgage repayments. The Browns’ house was not as desirable as the Austins’ (because the Browns were paying the landlord’s mortgage, other business costs and a small profit), but in other respects was very similar. Thereafter, they made the same life choices (which we can therefore safely ignore).
So what happened to the Austins and the Browns?
To understand their finances, we can ignore general inflation, but we need to remember that (on average), British house prices have risen at a significantly faster rate than general inflation. Over the past 70 years, Halifax bank calculates that house prices have risen by 300% in real terms (source) which means an average of 1.6% above inflation per year. Over the life of a 25 year mortgage, house prices rose by 48%.
The Austins paid their mortgage for 25 years. Of course, during that time, they were also paying interest, but they made the same monthly payment for the whole term of the mortgage, and cleared the debt after 25 years. Assuming that they were paying 5% of the loan per year (to cover interest and reducing the principal), over the 25 years, they paid 122% of the original value of the house, but in the end, they owned outright a house worth 148% of the original value.
The Browns started off paying the same monthly amount as the Austins. However, rents are a function of current house prices, not original purchase price, so every year the Browns’ landlord put their rent up by 1.6% above inflation. So, at the end of the 25 years, the Browns had paid 12% more than the Austins and were still living in a rented house. Furthermore, whilst the Austins’ mortgage costs dropped to zero after 25 years, the Browns had to carry on paying rent.
So what do we learn from this thought experiment?
- There is a comforting idea – comforting to those of us who have bought our own houses – that the value of our property is the result of our hard work. Poppycock! House price inflation takes no work whatsoever.
- The value of our property depends to the greatest extent on our ability to get onto the housing ladder early, and that depends of having money for a deposit.
- In the long term, renting costs more than buying a house, yet the people who cannot afford to buy have to rent.
- As a result of paying less in the long term (and paying nothing after paying off a mortgage), home owners will tend to have accumulated wealth which might be used to give to the next generation for house purchase or to become landlords. Housing capital is accumulative and tends to concentrate wealth.
Does this matter?
Housing security is fundamental to the well-being of individuals and families yet currently we have chosen to make the well-off secure and to give the well-off a simple method of increasing their wealth whilst those without capital are charged more and excluded from house purchase. This seems fundamentally unfair, as does the systematic concentration of wealth in fewer hands through capital accumulated with no effort. If we really wanted to level-up, if we really wanted Britain to be a property-owning democracy, we would do something about the housing market.
So what is to be done?
Well, personally, I’m going to come back to potential solutions in further blog posts.
Liberal Elite 