Why first-time buyers should think twice

If you think falling house prices have been good news for first-time buyers, think again.

First-time buyers had a tough time during the later stages of the 1995-2007 housing boom.

Priced out by the boom

With house prices rising for 12 years in a row, the average price paid by a first-time buyer (FTB) rocketed. According to the Halifax, the cost of a typical FTB property soared from £45,500 in 1995 to £148,500 in 2007. This is an increase of £103,000, or 227%. Put simply, prices for FTBs more than tripled.

Many who wanted to buy found they could not afford to buy even a modest starter home, and simply gave up trying to reach the bottom rung of the property ladder. Others scrimped and saved for years - or borrowed from the Bank of Mum and Dad.

Falling prices offer hope

The average price of a first-time buyer peaked at roughly £154,750 in June 2007. However, as the credit crunch started to gather pace, the cost of bottom-rung properties dived, as you can see from the table below:

Source: Halifax

Having peaked in June 2007, prices for FTBs plunged almost a quarter (24%) to a low of £118,200 in March. Since then, they've moved up by 3%, but this is a weaker bounce than we've seen elsewhere in the housing market.

Low deposits mean high rates

Although the typical FTB property now costs almost £33,000 less than it did when prices peaked in June 2007, this is of little comfort for first-time buyers. This is because huge numbers of mortgages catering to first-time buyers, who typically have small deposits, have been swept away by the credit crunch.

With house prices almost falling every month and the economy gripped by a recession, lending to the borrowers with small deposits has become much riskier. After all, if you lose your job and your property is repossessed, the lender wants to be sure of getting their money back. Hence, lenders are willing to lend less on each property than they used to, so the best deals today have lower loan-to-values (LTVs) than they did in the past.

In fact, a 90% LTV mortgage is likely to cost at least 1.5% more than the best deal on a 75% LTV deal. Before the credit crunch, you would have paid roughly the same!

Picking cherries

There is also a lot less competition for borrowers. First of all, there are fewer lenders now - with formerly big players like Northern Rock and Bradford & Bingley out of action (and good riddance to them as they were among the most irresponsible).

Secondly, in the new era of credit rationing, economic recession and rising bad debts, lenders don't have enough funds to lend to everyone. At least, not in the way they did in the past. Again, this is probably a good thing. Some people shouldn't have been lent to in the first place.

But all this means that, today, banks are cherry-picking. They are only lending only to those with large deposits, reliable credit histories and solid incomes. Which is great for most of us - but not so great for FTBs with small deposits, short (or non-existent) credit histories and low incomes.

A tale of two borrowers

Hence, although house prices have moved in the right direction for prospective first-time buyers, mortgage availability is a fraction of what it once was. And without a substantial deposit, putting that first foot on the ladder will remain a dream for many.

Here's an example of how a typical FTB's situation compares to a typical home mover, using the lovemoney.com mortgage service. I've assumed the FTB wants to buy a much cheaper home (worth £140,000) than the home-mover (who wants to up-size to a £240,000 house).

As you can see, our home-mover wishes to buy a £240,000 house, using his £60,000 deposit and yearly income of £60,000. Armed with a 25% deposit and borrowing only three times his income, he has no problem in securing an ultra-low rate of 2.49%. This means that his interest-only mortgage costs £4,482 a year in interest.

At £140,000, our first-time buyer's property costs £100,000 less, but he can raise only a 10% deposit (£14,000). His 90% LTV mortgage of £126,000 is also three times his yearly salary (£42,000). Alas, his lack of upfront cash makes him a riskier customer for lenders, so his interest rate is bumped up to 3.89% a year.

Thus, our FTB's mortgage is £54,000 lower than the home-mover's loan, but his interest bill is £419 a year higher, at £4,901. Note also that this search produced 119 deals for our home-mover, but a paltry six home loans for our first-time buyer!

Pricey loans and falling prices...

In summary, not only are there precious few deals available to FTBs with small deposits, but those that are on offer charge high interest rates (typically, 4% to 8%, plus fees). In my view, this 'mortgage apartheid' makes it very unattractive for first-time buyers to leap on the housing ladder.

Finally, as I warned in Get ready for the housing crash part II, despite the recent spring bounce, I expect house prices to resume their downward trend very soon. Hence, I have no plans to buy a house for at least another year -- and I would urge first-time buyers to be equally cautious!

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