The problematic rise of the ‘ultra-marathon’ mortgage
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About a decade ago, the FT’s Tim Harford wrote that paying off a mortgage was no longer the sprint it had been in the 1970s and 1980s, but had turned into a marathon. Today, it’s in danger of becoming an ultra-marathon — and that could mean trouble for the UK housing market, as it wrestles with higher borrowing costs and lower sales.
Back when baby boomers were buying their first home, they were faced with high mortgage rates and double-digit inflation, which — as many often remind us — caused serious pain in the short term. However, they borrowed much lower amounts relative to their income than today’s buyers and high inflation quickly eroded the value of their outstanding debt.
It was unpleasant, certainly. But the worst of it was over in a few years. And, thanks to rising wages, they were able either to pay off their mortgages long before their term ended or move home by leveraging their newly created housing equity and starting the process again. It provided the essential footing for the housing ladder which, over the course of the past 40 years or so, has created massive wealth.
In the past 15 years, though, things have been different. Thanks to historically low interest rates, mortgage repayments have been well within affordable levels. But to keep them that way as house prices spiralled and wage growth stagnated, buyers have had to take out longer and longer mortgages. And the economic conditions meant that many were likely to be stuck paying their mortgage for nearly the length of the term. In 2005, the average term for a first-time buyer was 25.8 years. By 2022 it had risen to 30 years.
But that’s only the average. The latest data from the UK Finance trade association shows that mortgage terms in excess of 35 years have become much more popular among first-time buyers in the past year. At the start of 2022, about 8 per cent of first-time buyers had a mortgage term longer than 35 years. By December — after the average mortgage rate for a five-year fix jumped from 1.6 per cent to 5.1 per cent — that proportion had more than doubled, to 17 per cent.
So why is this a problem? The most immediate concern is that first-time buyers are piling into an overpriced housing market by stretching the one part of the mortgage repayment calculation that had room for expansion. While doing so could help stop house prices declining, very long terms could become a permanent feature of the market — encouraging all borrowers to increase their mortgages. And this will have consequences.
The obvious issue is that a longer term means paying significantly more interest — at 4 per cent rates, every additional five years a first-time buyer adds to their mortgage term adds about half their initial household income in interest to the bill. This could potentially affect other spending or saving for a pension if rates stay high and wages stagnate again.
Choosing a longer term at the start of a mortgage also limits their options if they were to get into difficulty. The FCA has recommended extending the term to help existing borrowers who are struggling with higher repayments. Retirement age will be a limit to how far they can go. Most terms were already due to end by retirement (98 per cent by age 75), which is why we’re seeing longer terms being used more by first-time buyers than home movers.
But the most pernicious problem is that while a longer mortgage term may help first-time buyers get on what they think is a housing ladder, it actually limits their ability to climb it.
This is because a longer term slows your ability to build up equity, since more of your monthly repayments go towards interest costs in the early years than on repaying the capital. For example, at current mortgage rates, after five years a borrower on a 25-year term will have repaid more than double the amount of equity of a borrower on a 40-year term — equity that can then be used for their next move. At a time of slow house price growth, or even price falls, it could also increase the risk of negative equity.
And that’s if economic conditions allow a housing ladder to exist in the first place. Rising wages might suggest that trading up from flat to house to bigger house is currently possible, but falling prices make this more difficult.
Ultimately, the economic picture over the life of these 35-year-plus mortgages will be a major factor in whether first-time buyers have to run the full length of their mortgage terms — but the recent trajectory is far from reassuring. Hopefully, economic growth returns and wage growth continues. If they don’t, then we’re probably facing a more extreme version of the pre-pandemic housing market. Fewer moves, younger households stuck in homes that are too small, older households under-occupying family homes and a torrid time for all the parts of the economy dependent on turnover in the housing market.
For today’s first-time buyers, their ultra-marathon mortgage could be a gruelling endeavour — still, it’s got to be easier than being a renter right now.
Neal Hudson is a housing market analyst and founder of the consultancy BuiltPlace