Thursday, 27 November 2014

Refusal of Mortgages to Over 40's Shows Property Bubble Must Burst

A report from the Intermediary Mortgage Lenders Association shows just how ridiculous property prices have become, and why the bubble must now burst. Under the new mortgage rules introduced in the summer, lenders have to assess that borrowers will be able to repay it over the lifetime of the loan. With banks every week being fined billions of pounds for various forms of past misselling, they claim to be afraid of future similar fines, if they fail to adhere to these new guidelines.

Maybe, but its just as likely that the banks are more worried about themselves not getting their money back from overstretched borrowers, in a climate where property prices are in for a prolonged collapse. The basis of the refusal to lend to the over 40's and some in their late 30's, is that with a standard 25 year mortgage, anyone over 40 will still be trying to pay it off after they have retired, and their pension income is unlikely to be sufficient.

One answer to that would be for borrowers to take out 10, 15 or 20 year mortgages, but now that interest only mortgages have effectively been scrapped, such a shorter term mortgage would mean significantly higher monthly repayments. That means that despite the historically low current interest rates, many potential borrowers lack the necessary income to cover those repayments.

This is the real problem, and not the fact that people are taking out mortgages later, or that lenders now have to pay more attention to the ability of borrowers to repay. It has always been the case that people took out mortgages later in life, sometimes even extending to after they would retire. People in their forties frequently sold the houses they had bought when they first got married, in order to move up to something better. The difference is that in the past, house prices did not start off at such ridiculous levels, and they did not increase in price by such ludicrous amounts. That meant that someone who had maintained a reasonable job, was able to have paid off a large chunk of their original mortgage, and to have saved money to cover the difference required to by a better house.

Suppose you started off buying your first house in 1960. It might have been a terraced house costing £500, for example. If you'd stayed in employment, by 1970, you might have saved up say £800. In the same time, the price of the terraced house might have risen to £600. You would then put this total of £1400 together to buy a nice new semi-detached costing £1,500 in 1970, leaving you with only an additional £100 to add to what was outstanding on your mortgage. Over the last 20 years or so that would be impossible. Firstly, the initial price of houses was so high, that many people were stretched to cover the mortgage payments. They then had to borrow on credit to cover other purchases, for cars, durable goods etc. So, the chance of saving any money was extremely limited.

But, even if you could save, the price of houses was rising faster than the ability to do so. If you had a £15,000 house in 1990, it might have risen in price to a £75,000 house by 2010, but, the £50,000 house you had your eye on to move up to in 1990, was now a £250,000 house. The £35,000 gap you had to save up to cover in 1990, had become a £175,000 gap, and wage rises certainly had not and were not likely to go anywhere near covering that difference.

That is why from the late 1980's, as Thatcher deregulated financial markets, and started fuelling the debt binge that led to repeated bubbles, and the financial crashes that pockmarked the intervening period up to 2008, the bubbling up of property prices went along with the continual expansion of the income multiple. That is, in the past, the average house price was around three times the average income. Today, it is more like six or seven times, and in London it is as high as twelve times. That also hides a variety of other factors, which make the situation worse. 

If you measure house prices in each area against the actual median wages in that area, the actual relation is much higher, and closer to ten than six, in most areas. In 1971, 79% of UK households were multi-occupancy, 70% were occupied by married couples. Only 19% were occupied by single people, with a further 2% occupied by lone parents. By 2011, those figures had changed drastically. Only 59% were multi-occupancy, the number of married couples had dropped to just 40% with a further 12% co-habiting, and another 7% other multi-occupants. By contrast, the number of homes occupied by one person had almost doubled to 33%, with 8% occupied by lone parents. 

So, where in the past the average house was priced at only 3 times average earnings, there were usually two people on those average earnings paying to buy it, whereas today there is frequently only one! That is also a change that was encouraged by the Thatcher government, as it encouraged the development of a debt fuelled bubble economy.

The real problem is that house prices have simply been led up into an unsustainable bubble that could only be maintained so long as the amount of private debt could continue to be inflated. As once contributor to the Independent commented,

“First time buyers are now over 40 in some parts of the UK - and now over 40's can't get a mortgage. Apart from BTL landlords and money launderers who exactly is going to be buying all these properties to keep the prices propped up to unaffordable levels.

The property market has finally eaten itself.”

But, as was seen recently even the biggest BTL landlords are getting out, because they see that the market has peaked.

This is before borrowers realise the extent to which their repayments are likely to rise. The media keep pushing the line that central bankers will keep interest rates low. But, central bankers can no more keep interest rates low than they can keep any other price low. Interest rates like every other price are determined by the market, and the market globally is pushing interest rates higher. With interest rates in Britain at current levels that are as low as they have been in 300 years, even a modest absolute rise, will amount to a large percentage rise. If mortgage rates rise from 3% to 6%, that does not mean that monthly mortgage payments rise by 3%, it means they double! Someone paying £1500 a month now, would have to find an additional £1500 a month, or £18,000 a year. 

But, even a 6% mortgage rate would be below the historic average for mortgages. If mortgage rates went from 3% to 8%, then someone currently paying £1500 a month, would find themselves paying closer to £4,500 a month! This is the real reason banks are limiting loans to only those with the best chance of repaying the loans. For the last five years, banks have operated on the basis of “extend and pretend”. That is faced with large numbers of borrowers, who essentially could not maintain their mortgage payments, they have allowed borrowers to extend the length of the mortgage, and add their debts to the amount to be repaid. That allowed banks to pretend that these loans had not really gone bad. It meant the banks did not, therefore, have to begin foreclosing on the mortgages, which would have caused a firesale of properties, provoking the inevitable property crash.

Banks, therefore, have had no incentive to add to their stock of bad loans, even with the government acting as guarantor of 20% of the loan. But, as interest rates necessarily rise, the number of defaults must necessarily rise, and the policy of “extend and pretend” will be no longer sustainable, especially as the UK economy suffers a sharp slow down. The banks are trying to protect themselves against that inevitable property crash, but the bubble has been blow up so big that, when it bursts, it will be on a scale never seen before. Britain will face the same kind of property crash that already played out in the US, Ireland and Spain, but even bigger, because the bubble here itself is bigger, and the banks are unlikely to be able to escape the consequences.

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