Mortgage Advice Centre

The Nationwide reported the fastest rise in house prices since Dec 2006. In July house prices rose 1.6% to £160,244. The 12 month house price change is now only -2.2%

The rise in prices occured because of the continued low interest rates and shortage of houses for sale.

However, the upturn in the market may encourage many homeowners to start putting their houses on the market. There is a considerable number of homeowners who have been holding off putting their house on the market waiting for market to turn. These homes are known as a shadow inventory. Now, prices have risen for a couple of months, we could see an increase in houses on the market which will moderate price rises and prices could fall if interest rates start to rise again.

Mortgage approvals continue to show signs of recovery with data expected to show further improvement.

Quoted 2 Year Fixed Rate Mortgage Rates

The fall in base interest rates to 0.5% has yet to be reflected in fixed rate mortgages. Despite continued base rates of 0.5%, commercial banks are already  raising their fixed rate mortgages.

Commercial banks have been claiming that the cost of borrowing is going up for them. However, looking at the three month libor (interbank rate) this is not the case. Libor rates have actually come down quite sharply.

3 Month Libor

Note 600 base points is the equivalent to 6.0%. Current Libor rates are just above 1%

Commercial banks may also argue, interest rates are likely to rise in the future. But, as we mentioned in latest interest rate predictions, the Bank of England feels interest rates will stay low for a considerable time.

Why are Fixed Rate Mortgage deals remaining High?

• Less competition in the banking sector following merger between HBOS and Lloyds
• Banks desperate to recoup losses from bad debts and tracker mortgages with 0%
• Stagnant Housing market, making banks less willing to lend mortgages except with good profit margin

Will Fixed Rate Mortgages Become Cheaper?

Probably not. Despite base rates remaining low, the banks show little sign of making fixed rate mortgages cheaper.

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Best fixed rate mortgage deals

Data Source: Bank of England

House Price Earnings Ratio

This shows the ratio of house price to average earnings for first time buyers. Although first time buyers is only a segment of the market, the trends are indicative of wider trends in the ratio of house prices to earnings.

As expected, the ratio of London house price to earnings is higher than the UK average. This is despite London having higher wages than the UK average. The relative shortage of space for new houses, means house prices in London have been pushed up to over 7 times average earnings at the peak in 2007.

The long term average for house price to earnings ratio is 3.5.

In the last boom of the late 80s, the ratio got close to 5.0. This meant that 2007 set a new record for house price to earnings ratio.

Despite fall in the house price to earnings ratio it still remains above the long term average.

Is it possible for House Price to Earnings Ratios to Increase in the Long Term?

Long Term House Price to Earnings Ratio (FTB)

House price to earnings ratios could increase in the long term if:

• There was a period of stable and low interest rates, reducing the cost of mortgage interest payments.
• If parents increasingly give deposits to children to enable them to buy more expensive houses.
• If there is a continued shortage of housing due to restrictions on building new houses and continued growth in number of households.
• If banks are willing to lend mortgages with bigger income multiples or if banks / government encourage more - part rent / part buy schemes.

The Credit crunch of 2007-09 caused banks to abandon their previous reckless mortgage lending. 100% mortgages and mortgages 5 times incomes were quickly removed as banks ran out of funds to lend. There may seem little prospect of banks returning to this kind of lending, but, that’s probably what people thought in 1995 after last crash.

Problems of House Price to Earnings Ratio.

Just because the long term house price ratio could increase, doesn’t mean it will. If it does increase, it creates various problems:

• More difficult for young people to get on property ladder.
• Higher % of Income going towards cost of mortgages
• Re-distribution of income from young to old.
• Buying a house may depend on having generous parents.
• Increased pressure to take out risky mortgages several times income.

House Price statistics

This graph shows the rapid decline in interest rates and inflation in the past couple of years.

Some now feel the worst of the recession is over, and if the fragile recovery turns into a stronger economic growth, the interest rate cycle could be reversed with rates returning to levels of 5%. This would have a big implication for homeowners who are getting used to base rates of 0.5%.

Given the unprecedented nature of economic crisis, it is more difficult to predict how the economy will recovery. We have witnessed an unprecedented array of economic policies from the largest fiscal deficit since WW2, to Q.E. and zero interest rates. These policies will not continue for ever and the need to quell the rising deficit could hinder future recovery. Also, there are unknown factors such as how the extent of swine flu may impact on economic growth should the pandemic spread.

The most likely scenario is for interest rates to rise gradually during 2010. Despite, quantitative easing, I don’t see a rapid return of inflation. There is too much spare capacity in the economy. Current money supply figures indicate bank lending is far from returning to normal.

Also, next year in 2010 and definitely in 2011, there is a likelyhood the government will have to tighten its fiscal budget. Therefore, with tax cuts expiring and possibly higher tax rates, it will enable the MPC to keep interest rates low to avoid a double dip recession.

Base Rates

These graphs and statistics on the UK housing market put into perspective recent changes in the UK House prices. In particular it is interesting to note how the ratio of house price to earnings is still significantly higher than at the end of the last housing crash.

Long Term Trends In UK House Prices

The two  big house prices crashes seem mere blips in the long upward trend. It should be noted these prices are nominal not real (Inflation has not been taken into account). However, UK House prices have still risen much faster than inflation.
In 1952, average UK house prices were £1,811. If they had risen in line with inflation average house prices would be now £42,000…

Again the main feature here is the two crashes and spectacular growth in between. See article: Why are house prices so volatile

This suggests house prices have fallen back to trend growth levels. However, the trend in house prices is not a guarantee of what will happen in the future - just a reflection of what has happened in the past. See Japan or US for examples, of country where long term house price trend changes.

Even adjusted for inflation and even accounting for the two big house prices busts, house prices are still more expensive!

See article: Why are House prices in UK so expensive?

The volatility of house price growth

Affordability of Housing

It is interesting to note how low house price to earnings ratios fell in the mid 1990s at the end of the last crash. Also, how much house price to earnings rose by the peak of the 2007 bubble.

Just in case you need more evidence House prices are still expensive for first time buyers.

It is mortgage lending that drives demand for buying houses. But, the credit crunch is still hitting banks making them reluctant to lend.

Base Rates can’t fall any further. But, how long will they stay at 0% with house prices showing signs of recovery?

Housing Market stats at ONS

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Note Graphs can be reproduced freely on other websites, with link back to www.housingmarket.org.uk/ - a sister site of mortgageguideuk.co.uk/

Perhaps earlier than many thought, house prices have continued to stabilise. Halifax’s measure of the longer-term house price trend, which compares the past three months with the previous quarter, rose 0.8%, a positive rise for the first time since the autumn of 2007. House prices in July rose 1.1%. The Royal Institution of Chartered Surveyors have now changed their predictions for house prices. Instead of predicting a fall of 10-15% for 2009, they now expect house prices to be slightly higher.

From an economic perspective there are also growing signs of economic recovery. Manufacturing output increased, retail sales have nudged higher and forward looking indicators like purchasing indexes have showed improvements. Yet, despite, hopeful signs of economic recovery, many are still nervous about the fragility of the recovery. Bank lending remains close to record lows and consumers are still reluctant to spend on big ticket items.

These worries have encouraged the Bank of England to resume its policy of Quantitative Easing - creating another £50bn. The Bank are hoping this will lead to further lending and make the recovery more lasting.

Prospects for Future Housing Recovery.

Although house prices have fallen 25% since their peak, they are by no means cheap by historical standards. Price to earnings ratios are still much higher than their post 1990 crash level. It seems zero interest rates are encouraging homebuyers back into the market. House prices are also been kept high by the relative shortage of properties on the market. As the economy recovers in 2010, interest rates are likely to rise. Assuming a modest recovery, interest rates will not rise too rapidly and the gap between base rates and commercial rates may narrow again.