Upto June 2007, the mortgage lending market was very competitive and lenders eager to attract customers through offering non traditional mortgages such as interest only, low deposit mortgages and mortgages with high loan to income ratios.

However, beginning in the US, there have been many problems in the mortgage industry worldwide.

The US mortgage industry made many inappropriate loans to people, especially in the subprime (bad credit sector). In 2003, US interest rates were very low, so these mortgages were temporarily affordable. However, as US interest rates increased to 4.5% many homeowners suddenly found themselves with unaffordable mortgage payments and so they failed to meet their mortgage payments. This led to a rise in foreclosures (mortgage defaults) and many mortgage companies lost their money.

Furthermore, these risky mortgages had been bundled up and sold onto other financial institutions (in the form of CDOs). The idea was to diversify the risk. However, as the mortgage companies lost money so did so many banks. This made banks very reluctant to lend money. This caused a rise in interbank lending rates and a shortgage of funds in the money markets.

Therefore, it has been very difficult for the top mortgage lenders to finance new mortgages. Therefore, they have been looking for less customers, and in particular customers with large deposits and good credit history.

This shortage of mortgages has led to lower demand for houses and therefore lower house prices. Falling house prices have made mortgage companies even less willing to lend and therefore, mortgages are even more difficult.

If you bought a house costing £160,000 with a 90% mortgage. Your mortgage would be £144,000. A fall in house prices would still leave you with a £144,000 mortgage. It is just that the % of the house that is covered by a mortgage will increase. Your mortgage repayments will only change if there is a change in interest rates.

1. Negative Equity.

If you bought your house recently then falling house prices could put you into negative equity. This means that your mortgage debt will be higher than the value of your house. This is particularly a problem if your mortgage is close to 100% of the total house price. Negative equity, in itself, is not a problem. If you continue to live in the house and make your monthly mortgage payments your situation will not be affected. Negative equity is only a problem if you need to sell your house. For example, if you could no longer meet your monthly repayments, and the house was repossessed, then you would still owe money to the mortgage lender. This is a particularly painful position to be in.

2. More difficult to remortgage.

In recent years, booming house prices in UK and US have enabled homeowners to remortgage their house and therefore gain equity, which they can use to spend. However, if house prices are falling, it is going to be much more difficult to remortgage, unless you bought your house several years ago, when prices were much lower.

3. Prospect of lower interest Rates.

If house prices fall, then it enables the prospect of lower interest rates. This is because lower house prices tend to reduce inflationary pressure. Basically, as house prices fall, consumers lose confidence as they see their main assets decrease in value. This leads to lower consumer spending and can have a further knock on effect in reducing Aggregate Demand and economic growth. As inflation falls, Central banks are able to reduce interest rates without causing inflation to go above target (usually around 2%)
Therefore, perversely, falling house prices can lead to lower mortgage payments. However, it is worth noting that falling house prices do not necessarily mean lower interest rates (this is true in the current US economic climate) There are many other factors affecting inflation, apart from house prices. If these inflationary pressures remain, the cost of mortgages will not decrease.