Housing and Finance in the UK

Rising demand for second houses has caused higher prices, especially in local property hotspots such as tourist areas like the Lake District.
This can cause economic problems. In particular, local first time buyers may be forced out of the market. Therefore, they will either have to rent, or they may be encouraged to leave the area. This can cause a shortage of labour and damage local economies e.g. shops can’t get people to work. In addition, it can change the nature of local areas because it is populated by ‘visitors’ as opposed to people who live there throughout the year.

On the other hand, people who buy second homes may bring wealth and spending power into the area. It depends how long they spend in their second house. If it is only 2 or 3 weeks a year then the area will not benefit. If they rent the house cheaply to local people in the intervening years it will be less damaging.

It also depends whether supply can increase to meet the demand for second houses. The problem in the UK is that it is often difficult to build new houses, especially in these tourist areas most affected by people buying second houses.

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1. There is a shortage of Mortgage Finance.

This is probably the biggest factor at the moment. Since the credit crisis of 2007, when many US subprime mortgages were defaulted on, there has been a shortage of available finance. Because banks lost money lending in America they are reluctant to lend to new homeowners. British Banks are asking for bigger deposits and are charging higher interest rates. Therefore, many people who would like to get a mortgage are unable to find a deal in the current climate. This means many first and second time buyers are having to rent rather than buy. This is causing a big fall in the number of people able to buy.

2. The ratio of house prices to incomes increased to an unaffordable level.

The long term average for house prices to income ratio is about 2.5 – 3. Currently it stands at 5. This means the average worker needs to take out a mortgage upto 6 or 7 times their salary. However, banks will no longer lend this amount of debt. Therefore, many, especially first time buyers simply can’t afford to buy.

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The term mortgage implosion refers to the dramatic decline in the number of mortgage approvals in the UK and other countries affected by the housing downturn.

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.

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House prices are determined by a number of different factors. Firstly there are ‘economic fundamentals’ these are factors such as economic growth and the level of average incomes. However, in addition to the basic economic reasons, house prices are often quite volatile because other factors influence the level of house prices. In the UK and US we have seen the importance of speculation and investment in the housing market. This has caused house prices to rise more rapidly than incomes.

Also in recent years, the availability of mortgage finance has played an increasing role in influencing house prices. When mortgage companies are keen to lend a range of unconventional mortgages demand for housing will rise. But, in a credit crunch mortgage products are withdrawn leading to lower demand.

For more detailed analysis see: Factors that determine house prices 

Recently the drop in UK house prices accelerated. Surveyors reported the most pessimistic conditions since 1978. House prices falling at fastest rate since 1978 (link)

The house price falls are worst in areas such as Northern Ireland, the South West and East Anglia. Areas least affected include London, Yorkshire, and Scotland.

Lower prices are being driven by difficulties in the mortgage lending industry (see: can I still get a mortgage?), which have seen falls in mortgage lending by upto 40%.  The difficulties in the mortgage sector have occured because of the shortage of credit in the money markets. Many big financial institutions are experiencing grave difficulties in getting sufficient funding and the crisis may worsen before it gets better.

Will the Bank cut Interest rates?

If the Bank of England cut interest rates, then it may stem the house price falls because it would make the cost of borrowing cheaper. However, the persistence of cost push inflation makes cutting rates more difficult and so homeowners may not find mortgage rates any lower in 2008.

Factors which will prevent a crash of 1991

• Supply constraints still remain
• Interest rates are lower than in 1991. In 1991 interest rates were in double figures for several months making the cost of mortgage payments more than at present. The cost of mortgage payments is below the historical high

The last few months have increased the likelyhood of falling house prices in the UK.

These factors could contribute to housing price fall

1.  Increase in Mortgage Rates. Many banks are increasing their interbank lending rate; this is being passed on to consumers. Therefore, there is an increasing gap between the Bank of England’s base rate and the lenders Standard Variable Rate. This makes mortgages more expensive, despite base rate cuts.
2. Reduction in Number of mortgages available. The big mortgage lenders have been reducing the number of ’subprime’ and risky mortgage products. For example, 125% mortgages have been stopped and 100% mortgages are very rare. Mortgage lenders like the Nationwide have demanded a much bigger deposit from borrowers. With a marked fall in mortgage lending the demand for housing will continue to weaken.
3. People coming to an end of Fixed Rate Mortgage Deals. Many in the UK, were benefitting from being on low fixed rate mortgage deals. However, as these 2 or 3 year deals come to an end they will have difficulty switching to a new mortgage in the more difficult climate. Some will not be able to afford the new payments and so may end up with having to sell. Continue reading →

The North of England used to be a good place for first time buyers to get on the property ladder. However, in recent years the price of houses in the north has increased significantly, reducing the gap between north and south. The result is that many areas in the north are becoming as expensive as areas in the South.

However, the price of houses in the north has an increasing variance between different regions. For example within a city like Manchester or Leeds, house prices can vary by upto 80% between different areas of the city. Continue reading →

The decline of the US housing market continued with house prices falling 10% in the last month.

The house price falls are due to  excess supply, falling consumer confidence and a correction to the inflated house prices. There are worrying signs that US house prices have further to fall because the stock of unsold houses is still large. Also the financial turmoil in the credit markets means that the number of mortgage products on offer is decreasing. The cost of mortgages is also rising because of the difficulty of raising finance. This will reduce demand for houses.

There is also the concern that with house prices falling so much people will be deterred from buying because of the danger of negative equity.

However, it is worth remembering that many still buy houses to live in rather than an investment. Also the cut in interest rates from 4.25% to 2.25% should help improve conditions in the housing market in the coming months.

The UK stamp duty thresholds mean that buying a slightly more expensive house can lead to a big jump in the amount of stamp duty that you have to pay.

For example, if you buy a house for £249,000 the stamp duty is £2,490

However, if you buy a house for £250,000 the stamp duty rises to £7,500 or 3%

Clearly, if you are considering buying a house just above the threshold level, it makes sense to try and barter the price down and compensate the seller through other means.

For example, you might be able to get away with purchasing the furniture as a separate deal. Alternatively you could pay them just under the threshold and give them gifts in kind such as white goods to make up the loss.

Stamp Duty Thresholds 

Stamp Duty Calculator 

Homeowners pay

0% stamp duty on houses upto the value of £125,000

1% on homes priced between £125,000 and £250,000

3% for homes between £250,000 and £500,000

4% for homes valued at more than £500,000

However, the average first time buyer is still paying a lot more stamp duty because of rising house prices. It is estimated that the average first time buyer pays over £1,670 extra duty since 1997, when Labour came to power.

The number of houses valued at £250,000 or more has tripled over the past three years from 1.8million to 5.5 million in 2007. Therefore, many people are having to pay the extra costs of stamp duty, in addition to the extra mortgage costs.

Furthermore, house buyers are also faced with the cost of HIPS, which has been criticised for adding red tape and unnecessary costs to buying a house.