Are first-time buyers creating a debt time bomb?

David Kingman examines the possible dark side of more first-time buyers obtaining access to mortgagesMoney house

Today’s young people face enormous barriers when trying to get on the property ladder. Property prices are too high, mortgage finance is too scarce, and the size of the deposits which lenders require are too dear for all but the richest or most fortunate to afford.

However, despite all these obstacles, lending to new buyers does at last appear to rising (thanks partly to the government’s schemes). This should be good news. But with house prices so high, anyone who does manage to get on the property ladder faces a new problem – being burdened with excessive levels of debt. Now some commentators are arguing that the seeds of the next financial crisis are already being sown, as too many people will eventually be saddled with levels of debt which they can no longer afford.

Higher lending to first-time buyers

Firstly, the good news. Recent figures from the Council of Mortgage Lenders showed that the number of first-time property buyers had risen by 30% during the second quarter of 2013, as 68,000 mortgages were advanced to first-time buyers. This figure is still far too low if we want the millions of young people who are currently frozen out of the property market to be able to own their own place, but at least it shows the trend is heading in the right direction.

However, there was also some bad news. The average sum lent to these first-time buyers was £117,000 in July – almost as high as has ever been recorded (the pre-crisis record was £118,000, set just before the crisis hit six years ago). This means first-time buyers are having to bear a higher burden of debt in order to get on the property ladder than almost any previous generation, coming at a time when most of the workforce is having to endure stagnant or declining real wages. And house prices are still continuing to grow.

Here’s the dilemma. As much as millions of young people dream of getting on the property ladder, there is certainly an argument that enabling them to do so by swallowing more and more debt could in the end turn out to be drinking from a poisoned chalice. Several commentators have criticised the government’s “Help to Buy” scheme and other policies which are aimed at stimulating the housing market, as there is a danger that they will only inflate existing house prices if nothing is done to increase the overall supply.

Interest rate danger

Part of the reason why this problem is building up is that interest rates are currently at historic lows, and the new governor of the Bank of England, Mark Carney, has recently pledged not to raise them until unemployment falls. This means that if first-time buyers manage to get over the hurdle of having to find a very large deposit to pay for a house – either through Help to Buy, or from the generosity of their parents – then they can afford to pay the interest and repayments on a mortgage even if the debt is many times their salary.

However, the big problem with this is that interest rates will have to rise at some point in the future – and then millions of mortgage-holders may find they can no longer pay their debts. This would spell trouble for the lenders, and could even lead to a second “credit crunch”, according to Mr Carney’s predecessor, Mervyn King.

Richard Jeffrey, the chief executive officer at fund manager Cazenove Capital Management, recently gave a warning about this:

“The reason the UK recession was so deep was that the household sector had previously got itself into dire financial straits – encouraged, it may be added, by a protracted period of below-normal interest rates. Debt-to-income levels rose to unprecedented highs leaving borrowers massively squeezed when interest rates rose and again when real incomes were squeezed by persistently high inflation… Sadly, we have in the making, at least for a proportion of households, the next credit crunch.”

It is in society’s interests to make it easier for more of today’s young people to enjoy the responsibility of home-ownership, but not if it could lead to another debt crisis. To avoid this outcome, we need a bigger supply of new housing and lower house prices – although the transition to this will itself be far from painless.