In 2022-Q1, we have seen significant increases in Dutch mortgage rates. This, together with the continuation of house price increases, fuels the discussion related to housing affordability. This article assesses how affordability has developed over the past months and finds that affordability is at an all-time low. In addition to that, we compare affordability for existing homeowners and starters. Affordability for existing homeowners and starters is decreasing, but starters are impacted most.

Affordability has been a hot topic in The Netherlands for the past years, primarily due to the rapidly increasing house prices. However, house prices alone do not tell the whole story, as highlighted in the 2021-Q2 Dynamic Credit Dutch Housing Market Update [1]. As of 2021-Q2 the affordability for a 100% annuity loan had almost decreased to the same level as in 2008, which was the previous low when it comes to affordability for starters on the Dutch housing market.

In Q1 of 2022, we have seen significant interest rate increases, in contrast to the decreasing trend the years before. Higher interest rates mean higher mortgage installments, which in turn leads to lower affordability. Especially since the house prices have continued to increase in January and February of 2022 (+3.58%) [2]. In this article, we will assess to what extent this has impacted affordability and how affordability for existing home buyers has developed and how it relates to that of starters.

Affordability index

The affordability index used for our analysis tracks the developments of income in relation to the developments of net mortgage installments, assuming the borrower’s income falls in the top income tax bracket.

Important components to consider here are:

• House price developments As house prices increase/decrease, buying a house becomes more expensive/affordable as a starter is required to borrow more/less money.
• Interest rate developments As interest rates move up/down, buying a house will get more expensive/affordable because the costs of borrowing money goes up/down. For this analysis, we will consider that the borrower takes out a mortgage with a fixed-rate period of 10 years.
• Interest rate deductibility The tax rate at which people with an income in the highest tax bracket can deduct their mortgage interest rate has been lowered from 52% in 2013 (the tax rate for the highest tax bracket) to 40% in 2022 and will decrease to 37.5% in 2023. This is essentially making mortgages less affordable as the net mortgage installment increases.
• Eigenwoningforfait The tax that one needs to pay based on the WOZ value of one’s house. The tax rate has fluctuated between 0.50% and 0.85% since 2003.

From 2021-12-31 to 2022-03-24 (the most recent report date available at the time of writing this report), rates for the most important risk classes and fixed-rate period have increased between 67 and 87 bps. So what does this mean for the affordability index? On average, the 10-year annuity rate has increased by 81bps between 2021-12-31 and 2022-03-21. In combination with the 3.58% increase in house prices results in an index value of 93.5 for a 100% annuity loan, an all-time low since 2003 when the time series started.

This is a new low for the affordability index, in slightly less than three months the index dropped by 9.8 points. This is a larger difference than in most of the years since the start of the index. In concrete terms, this means that mortgage installments increased by 10.4% relative to the income of the borrower from 2021-12-31 to 2022-03-21.

Figure 1: Affordability index for a starter, assuming the house is financed using a 100% annuity loan. Source: LoanClear, 31-03-2022

Affordability analysis of starters vs existing homeowners

The Affordability index in Figure 1 gives a good representation of affordability for starters, but they only represented 30% of all transactions in 2020 [3]. What about the affordability for existing homeowners looking to buy a new house?

Generally speaking, buying a new house will be more affordable for existing homeowners than for starters. This is because existing homeowners have already built up some home equity, either by repayment of the loan or by the appreciation of the house. Only when house prices have fallen by more than what the borrowers have repaid on their loan, buying a new house will be less affordable for existing homeowners than for starters.

For this analysis, we consider the affordability of the ‘average house’ for an existing homeowner that purchased its first ‘average house’ 5 years ago. The index for the existing homeowners is normalized based on the 2008 monthly installments for starters, such that a direct comparison can be made between the two indices.

Figure 2: Affordability index for existing home owners (that purchased their first house 5 years ago) and starters. Source: LoanClear, 31-03-2022

What stands out when looking at the affordability index for existing homeowners is that the movements are similar to that of the affordability index for starters but are lagging. This is because affordability is highly dependent on the mortgage amount that the borrower took out to purchase their first house, which is dependent on the house prices at that time. In addition to that, the interest rate that was applicable at the time of purchase of the first house, as well as the interest rate that is applicable at the time of purchase of the second house have an impact on affordability.

Surprisingly, what happens with the house prices during the 5 years that the borrower owns the house has no impact on affordability in most situations. Only if house prices decrease significantly and a borrower is left with residual debt, affordability is impacted. This is because a residual debt usually has to be repaid within 15 years rather than 30 years and that the interest paid on the residual debt is not tax deductible [4]. For this analysis, it is assumed that the borrower is able to finance the residual debt at the same rate as the second mortgage.

Based on the difference between the affordability, we find that as of March 21st, 2022, buying an ‘average house’ for an existing homeowner who bought their first house 5 years ago is 1.75 times more affordable than for a starter. This is the highest difference we have observed since the previous high in house prices in 2008. As house prices increase, the affordability will go down for both existing homeowners and starters. However, relatively speaking the impact is smaller for existing homeowners, resulting in a larger difference. In addition to that, the impact of interest rate changes also has a relatively lower impact on affordability for existing homeowners has they have to finance a smaller portion of the house relative to starters, except for the situation where there is a residual debt.

The fact that affordability for starters has decreased relatively more than for existing homeowners is likely also the cause of the lower market share for starters in the Dutch housing market. With transaction volumes decreasing (-10.6% YoY in 2021-Q3 [5]), high prices can be sustained by existing homeowners selling houses to each other, largely financed by home equity rather than using mortgage loans. This can potentially decrease starter affordability even more.

References

[1] 2021-Q2 Dynamic Credit Dutch Housing Market Update

[2] CBS – Bestaande koopwoningen; verkoopprijzen prijsindex 2015=100

[3] Kadaster – Nog nooit zo weinig starters op de woningmarkt sinds 2006, 6 mei 2020

[4] https://www.consumentenbond.nl/hypotheek/restschuld-meefinancieren

[5] CBS – Koopwoningen; nieuwe en bestaande, prijsindex 2015=100, 13-01-2022