Mortgage Advice Centre

It is rather ironic that Spain’s banking system largely avoided the toxic mess of the subprime fiasco. Santander / Abbey (Spanish owned) has been one of the few high street banks able to keep a reasonable supply of mortgages as its parent company did not make the kind of losses many UK banks made. However, despite pursuing responsible banking, Spain is witnessing its fastest ever house price falls (House prices fell 7.6% in Q1 of 2009) as the global recession and glut in supply push prices lower.

Spain had a great housing boom during the period 1997-2007. According to the IMF, Spanish house prices rose 17% higher than market fundamentals suggested during this period, this was a bigger imbalance than the US, where house prices were estimated to be 12% overvalued. The boom in house prices was largely fuelled by investors, both domestic and foreign. The boom in prices also caused an unprecedented boom in house building. At the height of the boom in 2007, Spain built more houses than the UK, Germany and Italy put together.

Spain is now faced with a record 600,000 unsold properties, idly sitting by with few potential buyers in prospect. It is this glut of unsold properties that will push prices lower and mean prices do not recover for a long time.

In addition to the glut in supply, the Spanish economy has been badly hit by the global downturn. Unemployment, previously high, as risen to 18% of the workforce. Job losses have been particularly construction sector which once fuelled the economy. Spain has also found membership of the Euro creates problems as well as benefits. Stuck in the Euro, they are not able to devalue to regain competitiveness like the UK has in recent years.

Unfortunately, the outlook for Spanish house prices is grim. With economic recovery still in the distance, it will take a long time to entice buyers back into the housing market and deal with the surplus of Spanish housing.

If you always fancied buying an apartment on the Costa del Sol, there could be some real bargains in the next couple of years.

Spanish Housing Market

Mortgage lending is still very low with only 43,414 mortgages were approved in May. Net mortgage lending in May stood at just  £324 million. This was 10% of the level 12 months previous. Yet, despite, a reluctance to lend mortgages, Nationwide reported house prices again managed to rise for the third time in four months. Average house prices are now £156,442, 10% lower than this time last year.

The house price rises reflect a shortage of housing on the market. The price rise comes amidst thin trading, though some estate agents have reported an upturn in interest.

This graph shows how Bank of England base rates have fallen much more sharply than standard variable rates.

Even with base rates kept close to 0%, banks are starting to put up fixed rate mortgages. Generally, if you can take advantage of a fixed rate mortgage now is a good time to get it.

The increased gap between standard variable rates and Bank of England rates reflects.

• Banks wanting to increase profitability after losing money during credit crunch.
• Banks needing to attract savings to improve liquidity ratios.
• Interbank lending rates (3 Month Libor) not falling in line with base rates.
• Decreased competition between banks allowing greater monopoly power.

This graph shows the increased gap between saving rates and lending rates. Basically, this is a banks profit margin, and it has been increasing in recent years.

When Interest Rates Rise

One good thing about the gap between base rates and SVR rates is that when the Bank of England pushes up base rates, commercial banks may not pass on the whole rate rise onto consumers.

For example, when the Bank of England cut base rates by 5%, my lender (Standard Life) cut rates by about 2.25%. Thus if the Bank of England does push up interest rates back to 5% in 2010, I will be (hopefully!) insualated from some of the rise.

Competition and SVRs

In the Long run, I think there is legitimate concern over the growing monopolisation of the Banking industry. With 2 companies now controlling over 50% of the mortgage market share, there is scope for increased prices to consumers

Given the very low interest rates, now is a good time to be making extra mortgage payments in order to pay off outstanding capital.

Especially, in the early years of a mortgages, the mortgage payments are mostly weighted towards  interest payments. Only a small % is dedicated to paying off the actual loan. This means that the overall cost of mortgage payments will be higher. If you can make extra payments, it is a good way to make use of the period of low interest rates and reduce the overall cost.

The CML suggest there is a variety of responses to the low interest rates. A significant group of homeowners are making extra payments, whilst others are struggling to meet mortgage payments due to problems such as rising unemployment.

Depending on your type of mortgage you can arrange to increase payments. With interest rates very low, paying off your mortgage is generally going to be a more attractive option than saving.

Also worth considering is an offset mortgage which automatically uses savings in your current account to reduce mortgage debt.

Related

• How To Pay off your mortgage early
• Should I make extra mortgage payments?

The past two years have seen an acceleration in the shifting market structure of the UK Banking system.
For the consumer it represents bad news. The market has become more concentrated leaving less choice. In particular the UK Bank market is becoming dominated by the Big Two Banks - Lloyds Group and Santander.

These are the Top banks in the UK

1. Lloyds Group - Lloyds TSB, Halifax, Bank of Scotland
2. Santander - Alliance & Leicester, Abbey, Bradford & Bingley.
3. HSBC
4. Barclays - Barclays and Woolwich
5. Royal Bank of Scotland (government have 65% stake)
6. Northern Rock (nationalised)
7. Standard Charter
8. Co-operative Bank

Abbey has seen a growth in market share during the credit crunch as its parent bank - Santander in Spain avoided the worst of the credit crunch. The impact is that Santander and Lloyds Group control over 50% of the Mortgage market in the UK.

Recently, the Mervyn King, governor of the Bank of England gave a speech warning about the dangers of creating banks too big to fail. Unfortunately, the credit crunch has created an almost duopoly in British Banking which threatens to restrict competition and lead to higher prices for consumers in the long term.

This week the cost of fixed rate mortgages increased by more than the forward cost of borrowing - an early sign of increased monopoly power by banks?

Top 10 British Banks (2008)

This graph shows the changes in nominal and real house prices in the past two decades.

Real house prices means adjusted for inflation.

In the last housing crash from 1989-1993, inflation was significantly higher than the present period. Therefore, the fall in real house prices was quite dramatic. e.g if House prices fall 15% in a year but inflation is 10%. It represents a 25% fall.

Currently inflation is very low. So real house price falls are similar to nominal house price falls. But, the very low inflation means people’s mortgage payments are not decreasing in real terms like many may have expected

After the well documented housing bubble from 2000 - 2006, US house prices have shown a remorseless and long lasting decline.

Since the market turned in 2006, house prices are expected to fall by 41% by 2010. Some fear US house prices could fall by 48%. The interesting thing is that US house price to rentable income ratios and house price to incomes ratios have fallen (or become close) to pre boom levels

The US saw a relatively modest increase in house prices compared to other EU countries like the UK and Ireland. Yet, the price falls in US have been larger.

There are many reasons why US house prices have fallen so much

Supply Boom. In the US, the boom in house prices coincided with a boom in building new houses. This means falling house prices occured with a glut in unsold homes. This depressed the market further. This is one thing the UK did not experience to the same extent.

Recession and Repossession.

The recession and rise in unemployment has led to a continuing wave of home repossession.

Over Correction.

When House prices fall, they often fall for a prolonged period. Houses are not like stocks and shares where it is easy to buy when you think there is a bargain. It takes time for people to take the plunge and re-enter the market. Confidence is an important factor. When confidence is high, house prices can push house price to incomes ratios above long term average. But, when confidence is low, house price to incomes ratios can fall below trend.

House prices create a strong momentum effect. When they are rising, it creates a momentum for them to keep rising. But, when they start to fall there is a negative momentum. E.g. people don’t want to buy when prices are falling. banks don’t want to lend because it leads to negative equity. This momentum effect makes the price movements highly cyclical.

The interesting thing for the UK, is that house prices have been relatively minor. Looking at House price to incomes ratios, they are still a long way above the rates in the mid 1990s (ratio fell to 2.5). Currently they are around 4.0).

True, we did not have a supply glut, but the evidence of the US and the last UK housing crash suggests there is still further for house prices to fall (despite the recent figures

With UK interest rates at record lows, many are wondering how long they will remain close to zero?

If the experience of Japan is anything to go by, very low interest rates could last 10 years. However, I think it is unlikely that the UK will repeat the Japanese experience of a decade of deflation and zero interest rates.

The UK has pursued a policy of quantiative easing (increasing money supply). So far the effects of quantitative easing have proved difficult to evaluate. Even the Bank of England say it will take time to know what impact on the economy it has had. However, this increase in the money supply increases the chance of economic recovery and in particular inflationary pressure.

Also, since the start of this year, commodity prices, especially oil, have started to rise. These price rises will put upward pressure on headline inflation and also indicate the chance of a global economic recovery.

In the UK economy, economic data is still mixed. On the one hand, the large decreases in output seem to have faded out and there are tentative signs of recovery. Yet, at the same time, unemployment continues to rise and this is likely to depress consumer spending into 2010.

The medium term inflation forecast still points to the many deflationary pressures in the economy and inflation is forecast to remain below the governments target of 2%.

At the moment, any economic recovery is likely to be L shaped rather than V shaped. (This means we will not bounce back but experience a period of sluggish economic growth as we deal with the legacy of the credit bust and great recession.

For the moment, interest rates are likely to remain very low. Looking into 2010 it becomes harder to predict. Quantitative easing remains an unknown quantity and the inflationary impact remains uncertain.

Whilst interest rates will probably stay low for a reasonable period, I would still say this would be an excellent opportunity to get a fixed rate mortgage.

A study by hometrack showed that last month, house prices were stable in most regions, giving more evidence that the dramatic declines in house prices may be over. However, hometrack cautioned against calling the bottom to be reached. Last week a report by Nationwide predicted house prices would not maintain a lasting recovery until next year - 2010. This was despite Nationwide reporting a 1.2% rise in house prices during May. The good news is countered by the gloomy economic conditions and continued problems in the mortgage market. The CML reported a 9% fall in the value of mortgage lending last month.

Is Now A Good Time To Buy?

It is likely that house prices will fall. But, the magnitude of the falls will be limited and not severe. 12 months ago, it definitely made sense to wait. But, not that imperative has gone. For a short while, we could see a degree of house price stability - moderate falls followed by moderate rises. It is a good opportunity to bargain hunt and if you find a good value house and can get the mortgage, I don’t think the fear of house price falls should delay purchasing.

The other issue to bear in mind is that the low base rates will not last for too long. Despite a negative RPI inflation rate, the policy of quanitative easing is likely to see inflationary pressure return in 2010. As inflation rises interest rates could pick up sharply.

Looking back at the past two years it seems that the housing market is subject to irrational expectations helping to exaggerate booms in house prices that later prove unsustainable.

Why do Booms in Housing Markets occur and why don’t People see Them Coming?

The nature of the UK Property Market encourages volatility. With inelastic supply (unresponsive to changes in price) a change in demand causes a bigger % change in price. E.g. during boom the relative shortage of supply pushes up prices

Banks Encourage Bubbles and Aggravate Downturns.

With house prices rising, banks become much keener to lend. The last housing boom encouraged a range of unconventional mortgages which allowed more people to get on property ladder and enabled the house price to income ratio to increase.
However, as soon as prices fall, banks need to protect themselves from negative equity and falling prices. Hence the sharp rise in required deposits.

Difficulty of Predicting Housing Market.

It is true that many were predicting house price falls just before the housing boom turned to bust. But, it is also worth bearing in mind, people were saying they were overvalued and set to fall from 2002. House prices are still higher than in 2005.

Irrational Exuberance.

There is also an element of irrational exuberance. When prices are rising people tend to block out bad news. The potential of making large wealth gains appears tempting and there are no shortage of ‘experts’ saying how to get in on the bubble.

The big question is will the same trends in the property market be repeated again?

In the present climate, it is hard to imaging banks reverting to past mortgage lending. But, in the aftermath of the last crash. How many were predicting another boom and bust of even greater magnitued?

1. UK Housing Market
2. UK House price index