First-time buyers: how do they finance their purchases and what’s changed?

John Lewis and Fergus Cumming

The changing nature of first-time buyers

Average first-time buyer (FTB) house prices have risen by 60% over the past 15 years and homeownership has fallen. How did those who bought their first home finance it and how has this changed? i) We find that average incomes of FTBs have risen. ii) But age-cohorts with the most FTBs (e.g. millennials) have recently experienced below-average income growth. iii) FTBs are therefore increasingly richer than their classmates: in 2018 they had 1.8x the mean cohort income vs. 1.5x in 2006. iv) FTBs are also taking on bigger mortgages. v) But monthly FTB mortgage payments have actually remained flat as lower interest rates and longer mortgages mean the same monthly payment can service more debt.

Financing house purchase

In two previous posts we analysed houses as assets. In this post we flip things around and look at the liability side: consumers use mortgages to convert a stream of future payments into a lump sum to purchase a house today. FTBs pay for their house with a combination of a mortgage and a deposit. The chart below shows that FTB prices have risen by about 60% between 2005 and 2018. The lion’s share of this has been financed by larger mortgages (blue areas). The flat mauve swathe over the past decade show that higher deposits haven’t played much of a role.

Average loan size is equal to the average income times the average loan to income (LTI) ratio. Splitting these out, it transpires that the rising income of FTBs (darker blue) accounts for about twice as much as increases in LTI ratios (lighter blue). Let’s look at each of these in turn.

FTB income growth

Average FTB incomes rose by 30% over the period, a similar amount to average incomes. Prices rose by around the same amount, meaning that real wage growth was essentially flat. But the story is more complicated because FTBs are not a representative sample of the population as a whole. You are only a FTB once, so this year’s FTBs are a different set of people to last year’s. There is no reason why FTB characteristics should be the same each year.

To understand how these changing characteristics affect the average income of FTBs, we can write Y_i as follows, expanding out the equation:

So an individual FTB’s income is the sum of: the population’s average income (Y_pop), the gap between their age cohort’s average income (Y_Ci); and the gap between the individual’s income and their cohort’s average.

Summing this up over all FTBs, then dividing it by the number of FTBs (see Technical Appendix for algebra), we can write the change in the average FTB income as:

Where bars denote the average over all FTBs, L denotes lags, α_Cj denotes the share of FTBs accounted for by a given age cohort j and sigma means summing over cohorts. Each term has its own simple economic intuition:

The first is the most obvious: *population income growth*. Holding everything else constant, if everyone’s income rises by exactly the same amount, that rising tide lifts all boats by the same amount and FTB income rises in line with the population. We can further split this up into inflation vs. real income growth.

But each age cohort needn’t have the same income growth. If cohorts with more FTBs (e.g. millennials) saw faster income growth than c with fewer FTBs (e.g. pensioners), this *relative cohort income growth* would raise average FTB income faster than average incomes. That is our second term.

Next up, suppose this year we have, on average, *older FTBs* than last year. Since earnings increase with age, they’d be earning more on average than last year’s FTBs were. That would raise average FTB income even if everyone’s income grew by the same amount. This is our third term. (There is an interaction term between this and previous effect but this is very small in practice.)

Finally, suppose none of the above change from one year to the next, but instead FTBs were increasingly *richer than their cohort peers*. For example, if FTBs are increasingly drawn from the top end of their cohort’s income distribution, this will mechanically raise the average income of FTBs. This is our final channel.

Using data on income and age distributions, here is the decomposition:

The yellow bars were pushing down for most of the 2010s, as average real incomes fell over the period. Compounding this, the negative green bars show that those of prime FTBing age (e.g. millennials) had slower-than-average income growth. The tiny purple bars show that FTBs becoming older had only a very minor role. This challenges the popular narrative that FTB ages have risen — but matches our earlier finding that FTB ages had only risen by 11 months over the period.

In the other direction, the biggest forces are inflation (orange) and the effect of being relatively richer than your cohort average (red). Crunching the numbers, we find that in 2005 the average FTB had an income that was 1.5 times the average for their age, by 2018 that had risen to 1.8.

FTB mortgage size

Next we turn to the mortgage component of the first chart. We can decompose the change in LTIs into various parts. Holding all else equal, if people choose to spend more of their income on monthly repayments, the bigger the mortgage they can service. Alternatively, people can spend the same fraction of their income and afford a more expensive house if interest rates fall. A final possibility is that people can take a longer mortgage: paying the same monthly amount for a longer period translates to a larger mortgage.

The chart below shows what happens when add in these three terms (term, interest rate and PTI, in place of a single LTI term) to the first chart:

The grey bars show that falls in interest rates have made the biggest contribution to the rise in FTB prices over the last decade. The pink bars show that there has been some lengthening of mortgage terms since the Great Recession, but it is a relatively small factor in driving prices.

The beige bars show that the payment to income (PTI) ratio has actually fallen significantly since the Financial Crisis. That means people are now spending less on their mortgage as a fraction of their income than they used to, though we cannot separate out to what extent this reflects households’ financial planning decisions or criteria imposed by lenders.

Monthly mortgage payments

While the average price paid by FTBs for their first home has risen 60% over those thirteen years, nominal loan payments for FTBs (purple) have barely moved since 2009 with the same nominal outgoings.

Since nominal incomes have risen by 32% over the period, that means the average payments to income ratio has fallen as houses become more “expensive” in terms of the lump sum, the mortgages used to purchase them haven’t become “less affordable” in terms of monthly payments as a percentage of income. As the chart below shows, the average payment to income ratios on FTB mortgages have trended down from just over 26% in late 2008 to just over 17% in 2019.

The future evolution of FTBs purchases depends on many factors, including both the changing composition of FTBs as a group from year to year, and the interaction of interest rates, deposits and term lengths of mortgages. Given the central role of interest rates, we compute below the potential sensitivity of FTB mortgage size with respect to interest rates.

Holding everything else constant, the dots show what the average FTB mortgage size would look like if rates rose by 100bps, 200bps and 300bps, respectively. Markets don’t expect long-run interest rates to rise, and other variables are unlikely to be unmoved, so we view these as illustrations of the sensitivity to rates, rather than a prediction of future scenarios.

Interest rates 100bps above their current levels, all else equal, would reduce average FTB mortgage size by around £20,000. 300bps above (roughly equivalent to a reversion to 2005 levels) would reduce it by around £53,000 relative to 2019.

Concluding remarks

FTBs are a new set of people every year. But how their characteristics change has broader implications for how the housing market is changing as a whole — though here we don’t analyse quantities, or any broader issues around changing composition of housing tenure.

Our results support claim that average FTBs are increasingly higher up the income distribution for their age. And slower than average income growth for younger workers have worked against FTBs. But our results challenge the view that average FTB ages have got much higher. And while FTBs on average are borrowing more in nominal terms, they aren’t spending more of their income on mortgage repayments than before: cheaper credit has roughly cancelled out the effect of bigger mortgages.

John Lewis works in the Bank’s Research Hub and Fergus Cumming works in the Bank’s Monetary Policy Outlook Division.

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