There are many factors that Tdrive the housing market but two remain key – house prices and interest rate movements.
And while the market may not be displaying any trends unfamiliar to mortgage stalwarts who have followed its movements for the past few decades, the confluent rising of the two factors is making home buying a particularly fraught experience for borrowers and brokers alike.
One could argue that potential buyers can step onto the housing ladder at any time, just as existing borrowers can remortgage whenever they choose.
But if for either that time has to be the present, there is little they or their advisers can do other than take the financial brunt.
That said, for prospective buyers now may not be as costly as later in the year if house price growth continues as it has of late.
The latest Assetz House Price Watch report, which summarises the various UK house price indices including those from Nationwide, Halifax, the Department for Communities and Local Government and the Financial Times, indicates the average annualised growth in house prices in the year to December 2006 was 9.8% – up from 9.6% in November.
However, the average price of a home was down to 197,865 in December from 198,147 in November. Interestingly, the report concludes that interest rates have had little impact due in part to the imbalance between supply and demand which continues to drive house price growth and also because interest rates are still low in historical terms.
“This year the seasonal slowdown has been minimal despite rising interest rates,” says Stuart Law, managing director of Assetz.
“Shortage of supply will ensure that upward pressure on prices continues. And this will only ease if the Barker Review delivers a dramatic increase in new homes, which is unlikely in the short term.”
Invariably, as the focus on interest rates becomes more intense, so does the examination of their impact on first-time buyers. And even for buyers who manage to get on the housing ladder sooner rather than later, pundits are far from optimistic about their chances in the present environment.
Following the interest rate hike to 5.25% earlier this month which app-eared to catch the market by surprise, predictions of stagnation rang out from some quarters and lenders were sent into a flurry of activity, pulling and rejigging their fixed rates.
“This rise comes a month or two earlier than expected as many pundits were anticipating a rise later in Q1 2007,” says Mehrdad Yousefi, head of intermediary mortgages at Alliance & Leicester.
“The money markets are expecting a further rise during the first half of this year and this will affect the pricing of fixed and base rate tracker mortgages. For those looking for fixed rate deals it would be advisable to secure one now rather than adopt a ‘wait and see’ approach.
“There are still a number of good value base rate trackers available which are cheaper than short-term fixed rates for those people whose financial circumstances are more flexible and able to withstand further rises,” he adds.
Meanwhile, David Bexon, managing director of SmartNewHomes.com, says the latest rate rise could be detrimental to the market and sabotage a buoyant start to the year for clients.
“While new home prices continued to rise in December, the housing market as a whole experienced a fall in prices,” he says.
“A rise will force potential buyers looking to move in the first half of 2007 to remain in their existing properties for fear of escalating costs.
“First-time buyers who have stretched themselves over the past year to take their first step onto the ladder could be severely affected and this could deter many potential younger buyers from entering the market,” he adds.
The challenge for first-time buyers exploring other options to get on the housing ladder is clear, as Mortgage Strategy found when canvassing adviser and lender views in the market.
“The picture for first-time buyers is not rosy,” says Mark Gordon, head of product development at Platform. “There have been mild slowdowns in some of the most costly parts of the country – for example, prices in London were relatively static for part of last year. But since then they have been moving up again.
“There are also a lot of people trapped in rented accommodation not only because prices are high but also because they are struggling to get a deposit together. There is no magic solution – first-time-buyers are being forced to look at cheaper areas and at options such as co-buying.”
Gordon says fixed rate products make sense but they may not be too appealing now that lenders have re-priced their products.
“A broker is the best person to see for good deals because of the competitive nature of the market,” says Gordon. “Some lenders kept their existing terms and it’s wise to snap these up.”
In terms of future product choice, Gordon says providers are having to tread cautiously.
“There has been some evidence of greater flexibility in terms of offering higher salary multiples – 5 x salary is becoming fairly common,” he says.
“But if lenders start to offer terms which are too generous, the industry’s reputation will be damaged. We may see more products made available for the shared ownership market and for ex-local authority properties. Some first-time buyers may also consider self-cert options.”
But of course, first-time buyer options vary widely depending on location, with demand exceeding supply in London and the South-East but supply exceeding demand in the North.
Nick Gardner, director at Chase De Vere Mortgage Management, says this is reflected in house price growth figures which show London storming ahead.
“First-time buyers will find life harder because of rising interest rates which add to the cost of mortgages and make buying homes less affordable,” he says.
“Even if house prices stopped growing, with wage inflation still pretty low, it will take a while for most properties to fall within their reach.”
Lenders have begun offering much higher multiples of salary at the same time as lending according to affordability and this is a welcome move, says Gardner.
“This is a much more sensible app-roach and will help more people get on the housing ladder,” he says.
“But borrowers need to approach these offers carefully and not overstretch themselves. We are advising most to take fixed rates to protect against further rate rises.”
But how should brokers incorporate the potential for further interest rates hikes into their advice? Should they focus on fixed rates or are there other issues they need to consider?
Gardner says fixed rates are definitely the flavour of the month and rightly so.
“Many first-time buyers’ circumstances change quite quickly, whether through relationships, children or moving for work,” he says. “So they need to buy somewhere they can live in for the medium term, especially if they have borrowed a high proportion of the property’s value such as 100%.”
The fact that buyers may have to look at living in parts of the country they can afford rather than like is a big consideration.
But this stems from the fact that there continues to be a shortage of affordable housing, which means the market needs something more than the willingness of people to move around the country.
While the government must do more to increase the supply of affordable housing, brokers have to ensure they look after their clients.
“For many borrowers, taking out a fixed rate on an interest-only loan is the only way they have a fighting chance of getting on the housing ladder in certain parts of the country,” says Bill Warren, director of compliance at Complete Mortgage and Loan Services.
“The big headache for brokers is the possibility of another base rate rise – how should they counsel their clients?
“The danger is that there will be a negative effect on first-time buyers if the market overreacts,” he adds. “In theory prices will be more stable for first-time buyers to get a leg-up. But the cycle will slow so property won’t be available and buyers will have to rely on new-builds in many areas.”
Thankfully, the impact of interest rate increases on the buy-to-let market is less marked.
“Buy-to-let is in better shape because the lack of affordability for many first-time buyers forces them into the rental sector, so demand is strong,” says Gardner.
“At the same time, over the past couple of years we have seen lenders increase maximum loans, demand less rental cover or profit and use lower rates of interest to calculate rental profits.
“Whereas lenders used to demand that a property generated rental income equivalent to between 125% and 130% of the mortgage interest each month, that has fallen so that some lenders now only demand that 100% of mortgage interest is covered by rent,” he adds.
“The requirement for rental cover to be between just 115% and 120% is now pretty common.”
This means that more properties qualify for buy-to-let mortgages which helps to keep the market moving, says Gardner.
“If lenders stuck to 75% LTV and 125% rental cover there would be far fewer buy-to-let investors,” he says.
But as with any area of the mortgage market, buy-to-let should be approached with caution. Lenders’ criteria which include sizeable deposits and good rental cover are there to ensure landlords can cover their expenses and make profits from their investments.
“Given that some lenders only require 100% of mortgage interest in rent, you can see that naive investors could quickly end up in trouble,” says Gardner. “The key is good advice and preparation.”
Good advice will enable buy-to-let clients to take opportunities to build their portfolios if there is a downturn in the market.
“If prices fall back a little, this would represent an excellent buying opportunity for investors and we would encourage clients to expand their portfolios as long as they are not stretching themselves financially,” says Gardner.
“We are encouraging most of them to take a fixed rates so their yields are not affected by any further base rate increases.”
Landlords who have existing portfolios that they can leverage are in a good position, says Gordon.
“Buy-to-let and near prime are probably pretty similar in that there are lots of lenders competing for business and rates have come down accordingly,” he says.
The biggest winners in this time of interest rate volatility have to be borrowers with adverse credit. This is because lenders have been forced to expand their product offerings to the point at which the boundaries between prime and sub-prime have become blurred.
It is not necessarily the case that of the first-time buyer, sub-prime and buy-to-let markets, sub-prime is the one being squeezed the most in the face of challenging market conditions.
“Experience counts and brokers and packagers will not place business with lenders that do not come up with the goods,” says Gordon.
“With so many new entrants in the lending market there is little doubt that competition has never been so intense and this is good news for brokers in that product innovation is key and lenders know that they must stay hot on service if they want to retain their position in the market.”
Warren foresees the sub-prime market continuing to grow in 2007, and not just because of the recent interest rate rises.
He says this growth will come because people now have a different attitude towards borrowing money compared with previous generations. Conversely, this presents a major challenge for brokers striving to ensure they continue offering quality advice and the right products for their clients.
“There are so many new lenders, so many new products and so many variations of niches in the market for sub-prime that it is a challenge for brokers to be able to easily confirm they have selected and recommended the right products,” says Warren.
“And with the Financial Services Authority hovering and looking into the quality of advice being offered in the sub-prime market, this is a big issue.”
However, the sub-prime market is healthy despite uncertainty surrounding future interest rate movements.
“It is interesting that interest rates are up 0.75% compared with where they were a year ago,” says Warren.
“How well are those sub-prime customers who were probably having plenty of problems anyway coping with the increase in interest rates, and how are brokers going to manage their clients in this context?”
“Organised brokers will be going back to clients and checking that they are coping with the increased rates and even suggesting remortgages where appropriate.
“Managing clients is an important function that hasn’t always been in evidence,” he adds.
“Mortgage regulation and the requirement for advisers to manage clients and work closely with them on an ongoing basis is of paramount importance.”
Game on then for brokers who are able to simultaneously find the best products for their clients, ensure they offer the best advice and continue to review needs and circumstances while navigating their way through the market challenges ahead.
House prices are in the process of rising to a higher equilibrium level
By John Wriglesworth,economist
Interest rates are rising, inflation is rising, personal borrowing is rising and house prices are rising. Can this continue? No.
House prices can’t keep outpacing rises in household income whatever the level of interest rates. But the more pertinent question is – when will house price rises moderate and will they eventually fall?
The key to the end of the present housing boom (and an 8% rise last year is still a boom) is affordability. Average house prices are now more than six times the average household income – well beyond the previous peak of around five in the late 1980s which pre-empted the house price slump of the 1990s.
So is it time for another slump? The above analysis of the house price to income ratio suggests the answer is yes. But that ratio analysis ignores two important facts that influence affordability – interest rates and the value of personal sector non-mortgaged property assets.
In the early 1990s mortgage rates hit 15% which meant that typical interest payments as a percentage of average income reached a peak of 27%. Mortgage interest rates are now around 5% and while house prices have risen considerably relative to incomes, the cost of repaying mortgages has not risen by anywhere near as much.
Presently, interest payments as a percentage of average income are only around 17%. This is nowhere near historic highs. Lower interest rates mean that people can borrow more and repay less than in the past. Consequently borrowers can afford more expensive houses. This increases demand and puts pressure on house prices to rise to higher levels relative to income.
I believe the house price rises we have seen over the past 16 years signify a move towards a higher equilibrium level that will be supported by historically low interest rates.
Another factor to be considered when assessing affordability is that most people trading up in the housing market now have much more equity in their existing houses than has previously been the case.
Take me as an example. In 1994 I bought my Clapham house for 190,000 with a 170,000 mortgage. In 2001 I sold it for 500,000. The 330,000 equity built up plus the modest income rise I received over the period meant I could buy another house for 800,000 in 2001. While I am not declaring my income at the time, I can confirm that the house price was considerably more than six times my income.
Despite this high multiple, my mortgage repayments were easily affordable. As most house purchases are made by existing home owners who typically have a significant amount of equity in their homes, they can easily afford new houses with prices considerably higher than their incomes. There is no pressure for multiples to fall.
House prices will rise by around 6% this year and then not fall over the next few years. The only factors that could cause a fall are a significant interest rate rise, by which I mean 1% or more, or a sharp rise in unemployment, by which I mean to 1.3 million or so. No economists are predicting such a pessimistic scenario and I agree with them. It is more likely that Jade Goody will be the next head of the Commission for Racial Equality than that the housing market will crash in the next three years.
Housing market will not see a sharp correction
By Fionnuala Earley, group economist at Nationwide
Our overall view of the economy in 2007 is fairly benign and this underpins our forecast for house price increases of between 5% and 8% in the year. However, a number of uncertainties make it difficult to establish a clear view about the direction of the economy and the profile of the market cooling we expect.
During 2006 most housing commentators were surprised by the strength of the housing market. Three factors explain this buoyancy in 2006 – the strong economy and labour market, the high level of immigration adding to housing demand and the slow response of housing supply to changes in demand. As first-time buyers were pushed out of the market their demand was more than replaced by buy-to-let investors wanting to move into the market for investment purposes, perhaps as a supplement or alternative to equity-based investments.
Looking at 2007, all these drivers are still valid. The economy has been growing rapidly and the labour market remains in fairly good shape with nothing on the horizon to suggest the rate of unemployment will increase dramatically. Affordability will dampen demand from all sectors of the market but with little obvious threat to employment, the fundamentals for an orderly cooling of the housing market are in place.
The biggest development following our forecast was the unexpected increase in the base rate in January. While a string of stronger data made an increase in rates likely, the timing caught most commentators by surprise. Our view is that this is a pre-emptive move and that the Monetary Policy Committee will be able to leave rates on hold for some time.
But uncertainty about the rate of wage growth adds risk. If wage growth spirals upwards, one or two more increases in the base rate are plausible. This would have a significant impact on housing market confidence and buyers’ expectations of house price growth, which would accelerate the rate at which we expect the market to cool in 2007.
However, our central view is that momentum from 2006 will still feed into the market in the early part of 2007 and the rate of house price growth will moderate significantly in the second half and into 2008. In the last rate-rising cycle it took around seven months and four increases in rates before a change was apparent in the annual rate of house price inflation. This is not to suggest the market shrugs off early rate rises, only that momentum carries the market for a little while before a dampening of demand shows up in house price data.
Signs of weakening demand show up more swiftly in activity levels and there is some evidence of this already. Estate agents saw a fall in the number of buyer enquiries in December even before the surprise rise in rates.
Overall, while increasing interest rates are not good news for mortgage borrowers, the macroeconomic fundamentals and continuing supply constraints in the UK are still fairly supportive for the housing market. Without wishing to play down the risks that higher interest rates present to the housing market and the economy, the data available suggests an orderly cooling similar to that seen in 2004, rather than a sharp correction as seen at the start of the 1990s.