During the 1970s and 1980s, mass homeownership combined with high inflation and high interest rates to create the concept of the “housing ladder.”
This was the generally accepted notion that a couple would typically buy a starter home in their 20s, use the built-up equity to upsize to a home suitable for growing family and then again to a larger home, all within fifteen years or less.
This housing market pattern became the norm. Many people still think that the current housing market is in some way an aberration of this and expect the housing ladder to re-emerge. However, in truth, the housing ladder was an artefact of the specific economic conditions that prevailed at the time, and will only resurface if we return to an era of high inflation and high interest rates.
By analysing the high inflation and high interest rate period between 1970-1990, when the housing ladder was at its peak, and 1998 to 2018 - during a period of low inflation and low interest rates, with a broken housing ladder - we are able to see where and why this breakdown occurred.
• Between 1970 and 1990, the average rate of inflation (RPI) was 10.1%.
• Average earnings were £1,080 but were growing by 12% (on average) per year until 1990 (2% real earnings growth)
• Average mortgage interest rates were around 12%
• The average starter house price in 1970 was £4,975
The economic state in 1970 meant, in theory, a couple would have been earning £1,620, and with a 12% mortgage rate could have bought a £3,281 starter home for £405 per year of repayments. This is assuming that house prices rise in line with average earnings, family homes are always priced at 50% higher than starter homes and that large homes at 100% higher than starter homes.
Based on the average couple’s situation from 1970 to 1990, inflation and wage increased rapidly, eroding their mortgage debt. This meant that, despite rising house prices, they were able to upgrade to a family home in 1976 and a large home in 1982, thereby “climbing” the house ladder. By 1990, their mortgage repayments are only 9.1% of gross earnings, despite having upgraded their house twice.
• Between 1998 and 2018, the average rate of inflation (RPI) it was 2.8%
• Average earnings in 1998 were £15,100, and grew by an average of 3% per year (almost no real earnings growth)
• Average mortgage interest rates were around 4.5%
• The average starter house price in 1998 was £93,130
In comparison, average earnings in 1998 were £15,100, so the household income is theoretically £22,650, meaning couples can afford £472 per month of mortgage repayments on an average priced starter home: £5,664 a year.
As a result of the changing economic climate, buyers have to wait until 2011, thirteen years, before they can afford to upgrade to a family home and are unable to afford a further upgrade to a larger home within the 20-year period.
At the end of the 20 years, despite not having been able to upgrade to a large home, their mortgage repayments are still 16.5% of their gross income due to the fluctuating interest and inflation rates.
The low inflation and low interest-rate environment from 1998-2018 meant that it took more than twice as long to move up to the second rung on the housing ladder than from 1970-1990, leaving the top rung out of reach.
The existence of the housing ladder depended on inflation rapidly eroding the mortgage debt, which allowed buyers and sellers to build up equity that could be put towards a new home. The key difference between these two economic climates is the ratio of house prices to earnings. In the high interest rate environment, a starter home costs just about double the initial household earnings. In the low interest rate environment, the starter home costs over four times initial household earnings.
Of course, there are still buyers today snapping up the larger and more expensive homes, but these purchases are now driven more by inherited wealth opposed to accumulated equity and will remain out of reach for those who are not lucky enough to inherit a sizeable sum from the earlier generations of homeowners.