Gloomy at first, but a sunnier outlook

19 July 2010

The emergency Budget drew the usual confusing messages from economic commentators - ’great news for the deficit’ and ’good news for companies’ but ’bad news for the low-paid’ and ’VAT is up so we may see a fall in demand’. Whatever the impact, there will be a knock-on effect for our industry but will this be positive or negative?

To find the answer we must assess the Budget against the current situation in the housing market. In the first four months of 2010 we saw a cautiously positive trend, with housing transactions up on the same period last year but only by single-digit percentages.

June saw a change in this trend, with transactions falling below last year’s figures.

This could be the result of several factors. First, the uncertainty surrounding the general election was followed by some pretty frightening messages from the coalition government about its proposed austerity plans. Then the World Cup added to the complexity of the situation. By all accounts, a combination of these events prompted the current situation.

What’s happening across the pond?
Recent trends in the US represent a setback for house builders. Following the cessation of the special $8,000 tax credit for first-time buyers new house construction declined by 10% in May. An additional drag on the house building sector is unemployment, which is running at 9.7% despite home affordability being relatively low.

Overall, the Budget will hurt as it was designed to but it will also bring medium-term benefits

On a more positive note, many Americans favour long-term fixed rate mortgages and 30-year deals have fallen to 4.75% compared with 5.38% a year ago.

And back in Blighty?
UK house building remains subdued compared with a couple of years ago. We are seeing some sites reopen but this effect is regional. Q3 2007 saw 55,670 new-build starts. This fell to 25,140 in Q3 2008 and bounced back to 30,530 for the same quarter in 2009.

New-build is critical to the stimulation of the housing and mortgage markets but even if stock levels improve it remains difficult for first-time buyers to get on the property ladder.

Many house builders are doing their bit to encourage purchasers by offering to pay Stamp Duty in some cases, or help with conveyancing fees. But first-time buyers still need at least a 10% deposit, with larger amounts required for lower rates. Again to end on a positive note, it was revealed recently that the average two-year fixed rate has fallen to its lowest level for seven years.

The VAT effect
In the UK the rise in VAT to 20% next January could affect the housing market by adding to the cost of buying a home, including conveyancing costs such as search fees, estate agency fees and Energy Performance Certificate prices.

On the other hand, we may see pent-up demand from buyers released early as they look to avoid additional VAT costs. Meanwhile, some retailers may decide to bear some of the increase by cutting their margins so we could see a stronger second half to 2010 than has been widely predicted. That said, if the VAT effects of a year ago are repeated we could see activity tailing off early next year.

Will all this help the remortgage market?
As we all know, the remortgage market is a shadow of its former self. Q4 2008 saw £24bn of remortgages - 54% of all lending. Just a year later this had fallen to £12bn, constituting only 30% of all mortgages.

In the short term there may be a marginal improvement in remortgaging, especially as borrowers on attractive SVRs decide to trade these for raising capital to fund home improvements or lifestyle purchases. In this way, the Budget could provide a much-needed shot in the arm to the remortgage market as borrowers bring forward planned expenditure to beat the VAT hike.

For example, a borrower planning an extension costing £60,000 could save £1,500 in VAT simply by completing the work before January, so lenders can expect to see an increase in business as borrowers bring forward spending plans.

That said, the bulk of SVR customers will remain on these deals for some time to come, as most forecasters believe the Bank of England base rate will remain low for at least another 12 months. The VAT increase itself will contribute to this trend, with rising living costs reining back consumer expenditure and holding down inflation.

And the attraction of luring customers away from other lenders will also be reduced if banks are limited in the amounts they can lend, while the remortgage market will look less attractive to lenders if they find they can achieve most of their lending targets by lending on a burgeoning home purchase market, buoyed by rising house prices. This means we are unlikely to see a big increase in the number of products targeting the remortgage market.

So where now?
We’re in for a bumpy short-term ride with some hefty boulders on the road - namely increases in unemployment and higher taxes, along with overall uncertainty as the Budget bites.

But in the medium term things are likely to improve somewhat, with the deficit falling, interest costs remaining low and house sales picking up.

Housing transactions have suffered since the election and mortgage volume has flattened in response. As confidence improves fixed rates will become more competitive for those with reasonable levels of equity, and the preference in this country is still for owner-occupation.

So overall, the Budget will hurt as it was designed to but it will also bring significant medium-term benefits. In a couple of years, as inflation rises further and interest rates start to increase we should see the remortgage market pick up.

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