Unit 1 Micro: FirstBuy, Affordability and Effective Demand in Property

For hundreds of thousands of first-time buyers, getting a solid foothold on the housing ladder has been tough in recent years. Falling prices and lower mortgage interest rates ought to have improved affordability for would-be purchases of a new house or flat but the barrier of having to save up a deposit in order to qualify for a mortgage has become higher causing many to be frozen out of the market. The number of people renting private accommodation in England has increased by 55% in the past six years as first-time buyers struggle to make purchases.

Economists use a term known as effective demand to describe demand that is backed up by a willingness and ability to buy. There are few better case studies in low effective demand than the difficulties facing first time buyers in the UK property market. A new government scheme is designed to offer relief.

Over 100 house builders including Persimmon, Barratt Developments and Bovis Homes have signed up to a new scheme called FirstBuy that allows house builders to give consumers a loan of up to 20 per cent of the purchase price. Assuming that a mortgage loan covers 75 per cent of the price, this would mean that potential buyers will have to find just 5 per cent of the price as a deposit. Well known mortgage lenders including Halifax and the Nationwide are also supporting the scheme.

FirstBuy is only available to people earning less than £60,000 per year and is solely for mortgages on new-build properties - the government is keen to raise the level of new house building and tilt the balance in favour of a greater supply of affordable properties. The 20 per cent FirstBuy equity loan will be interest-free for five years. In the sixth year, interest will be charged at 1.75 per cent and at the RPI (Retail Prices Index) measure of inflation plus one per cent thereafter.

According to news reports, in July 2011, the average deposit needed to buy a house in the UK is £20,000 to £25,000, or 20pc of the purchase price.

The average age of the first-time buyer with no support from their family is now 37, and there are 1.4m households who aspire to own a home but are unable to do so because of house prices and mortgage availability.

Will this scheme provide an effective way to improve affordability and increase demand for younger home-buyers? Or is this particular government intervention a drop in the ocean of a much bigger problem?

With over 1.4 million households effectively priced out of the market, a new scheme designed to assist 10,000 people over two years will probably make little genuine difference.