Low interest rates keep house affordability far from danger levels despite rising prices

PROPERTY: House prices in the Republic are historically high relative to income but, when the cost of borrowing is taken into account, affordability is "far from danger levels and will improve this year".

That's the thesis put forward by Dr Dan McLaughlin, chief economist at Bank of Ireland.

One way of measuring the affordability of mortgages, and therefore the underlying strength of the housing market, is to compare the cost of paying back a typical mortgage relative to income. One such model is used by Dr McLaughlin in the new quarterly Irish Property Review, published by the Bank of Ireland.

In this model, average pay in the manufacturing sector is used as the income variable. The average new mortgage in 2001 - €115,000 (£90,500) - cost some €8,450 in repayments over the year, so accounting for more than 31 per cent of average income.

This represents a sharp rise over the previous year (29 per cent), reflecting a combination of larger loans and higher interest rates.

On this basis affordability clearly deteriorated in 2001, Dr McLaughlin explains, which would generally be negative for mortgage demand and, therefore, house prices.

Yet affordability is still far from the danger levels associated with falling real house prices. In the early 1980s, for example, the spike in mortgage rates pushed this affordability measure up to 37 per cent before falling back to less than 20 per cent by the end of that decade.

Bank of Ireland predicts that mortgage affordability is likely to improve sharply this year, with repayments as a percentage of income falling to around 28 per cent.The average amount borrowed for a new mortgage will still rise, by around 5 per cent, with pay increasing at double that rate, believe it or not, according to Dr McLaughlin.

Last year was the 14th consecutive year of rising house prices in the Republic, bringing the cumulative gain since 1987 to 350 per cent. The average house cost €207,000 in 2001, or 7.7 times average pay in the manufacturing sector.

Against the backdrop of a new lower interest rate regime, this is not quite as awful as it seems - but try telling that to hopeful first-time buyers on average incomes.