House Prices and Risky Mortgages Up, But Demand is Beginning to Fall

The number of house buyers taking out high loan to value (LTV) mortgages hit a post-crisis peak last month according to figures released by e.surv, the largest chartered surveyor in the country.

The amount of borrowers taking out mortgages with a deposit equivalent to 15% or less than the value of their property reached 10,898 last month, rising from 9,750 in May and 7,166 a year ago. High LTV mortgages now account for around a fifth of all new mortgages issued, having climbed from one in nine since this point last year, representing an increase of 52%.

While this is still significantly lower than the level reached in February 2007, before the dawn of the financial crisis, when 41,745 high LTV mortgages were issued and accounted for one third of overall new mortgage lending, the fact remains that we are now witnessing the highest level of high LTV lending since April 2008.

Perhaps the most disconcerting conclusion that can be drawn from e.surv’s report is the fact that there is a distinct and substantial North/South divide in relation to the number of high LTV mortgages being issued. High LTV mortgages as a percentage of all mortgages issued stands at 27% in both the North West and Yorkshire respectively and 25% in the North East, while the figure in the South is far lower: 12% in the South East, 15% in the South West and just 7% in London.

However, according to Richard Sexton, director of e.surv, in many ways, high LTV mortgages are a good thing, particularly because of the fact that they draw first time buyers into the market and open up the possibility of home ownership to a number of people who would otherwise be unable to obtain a mortgage.

Mr Sexton said that:

“A glut of high LTV deals has tempted borrowers back to the market, supporting a flood of first-time buyers over the last year. Banks have increased their arrays of high LTV options, reducing prices and helping keep the dream of homeownership alive for the bottom of the market. It was needed. The base rate has been stuck at 0.5% for five years. Wages have shown sluggish growth. And the cost of getting onto the housing ladder – and saving for a deposit – has been building. More high LTV lending prevented a flat lining of first-timers, at a time when all the odds seemed stacked against them.

“The tides may be about to turn for borrowers. High LTV lending may start to tail off in the wake of new regulations. Saving for a deposit is not going to be made any easier by the introduction of loan-to-income caps.”

However, according to the Royal Institute of Chartered Surveyors (RICS), the tide may already have begun to turn. In a report released today, RICS noted that average high loan-to-value ratios among first-time buyers had dropped for the second month in a row and now account for 85.1% of such transactions, falling from 85.3% in April.

Furthermore while, as Mr Sexton notes, recent macroprudential methods announced by the Bank of England have focussed more on high loan to income (LTI) than LTV mortgages, the, albeit limited, empirical data that exists suggests that any policy intervention aimed at limiting lending activity generally has a contracting effect on markets, most often causing transaction activity to decrease after around three months and price appreciation to slow three months later.

This perhaps explains the findings of the Council of Mortgage Lenders (CML), who announced today that, despite the recent interventions into the market conducted by the Bank of England, the amount of first time buyers taking out mortgages has failed to decline. While the CML claims that the effects of the new Mortgage Market Restriction (MMR) rules introduced by the Bank of England in April have so far been “subtle”, the truth is that it is simply too early to judge the effect of the Bank’s measures.

So Mr Sexton is most probably correct in asserting that the Bank’s intervention will serve to limit the amount of high LTV mortgages issued, and this is indeed a problem for first time homebuyers. He is also correct in stating that high LTV loans are not necessarily a bad thing, though only partially.

Generally, high LTV mortgages are only risky mortgages if issued to poor credit quality borrowers. So long as stringent and comprehensive checks are applied to prospective property speculators, then high LTV mortgagors do not pose high levels of risk of mortgage deviance resulting from illiquidity or, ultimately, default.

The MMR changes should serve to limit the risk of overexposure to subprime lending of the type that occurred before the financial crisis. Again, while principally focussed on the problem presented by overly high levels of high LTI mortgages, the MMR policy has the parenthetical effect of limiting potential vulnerability of high LTV borrowers.

High LTV mortgages do however become a sizeable problem when house prices begin to fall. When house prices depreciate, many homeowners find themselves in negative equity, with mortgages larger than the value of their property. If house prices continue to appreciate, or remain stable, sensibly vetted homeowners with high LTV mortgages are not a significant risk to either the housing market or the wider economy.

According to the report released by RICS today, though the effects of the MMR rules are unlikely to have filtered through enough to have substantially affected the market yet, the increasingly tough rhetoric emanating from the Bank of England over the past few months is serving to have a dragging effect on the UK housing market.

While this has not served to significantly halt increasing levels of house price appreciation, as evidenced by the 2.3% quarterly increase announced by Halifax yesterday (see National Homebuyers article ‘Property Price Ambiguity is the Order of the Day’), according to the RICS report, it has already begun to slow transactional activity, particularly in the country’s primary housing market hotbed, London.

RICS Chief economist, Simon Rubinsohn, said that:

“Buyer enquiries in the capital are now slipping back which suggests that the very sharp upward move in prices will flatten over the coming months.”

In confirmation of Mr Rubinsohn’s statement, respondents reported a decrease in the demand over the past month, by a majority of 30%. Additionally, though RICS describe a net balance of 53% of respondents who reported an increase in prices in June, up from from 56% in May; the balance of respondents expecting prices to rise over the next quarter declined dramatically from 46% in May to 26% in June.

To judge from all the data released today, by both RICS and e.surv, it would seem there is a good chance that the UK may well be approaching peak levels of national house price inflation and the blue skies of stable house price appreciation stretch as far as the eye can see.

Or do they? That’s not a raincloud over there is it?

According to Rob Wood of Berenberg, the soaring level of house price inflation is simply pausing, rather than halting, as lenders adjust to the additional administration required to accommodate recent policy changes in their business models. The market is still drawing a breath. Mr Wood said:

“Tighter regulations introduced in April through the MMR are mainly an administrative problem for banks. It now takes much longer to process applications, which has slowed housing transactions without hurting prices much.”

This would explain the combination of a lag in demand and the continuance of strong price increases currently being experienced in the housing market.

Mr Wood has also predicted that house prices will increase by 10% this year and 10% again in 2015.

Howard Archer of IHS Global Insights agrees that, while house prices will continue to rise, “there will be some easing back in house price gains”. Mr Archer predicts a 4% increase in house price appreciation for the second half of this year.

However Jeremy Duncombe, an economist with Legal & General, believes there will continue to be an “acceleration of house price increases” in the near future.

In short, if prices continue to soar at the rate at which they have been for the past year or so, the existence of a bubble in the housing market will become completely undeniable and, as we all know, the problem with bubbles is that they burst. If this happens, and house prices fall dramatically, those with high LTV and LTI mortgages will be left highly vulnerable and at risk of default and, subsequently, foreclosure. One does not have to attempt to predict the effect this could have on the wider economy, recent history provides all the unsettling answers required.

However if prices rise at a stable and therefore sustainable rate then these types of mortgages will probably prove to be less risky and many commentators would have you believe.

Of course the real test will come when interest rates eventually rise. That is the real storm cloud on the horizon; one which most are hoping will rumble and roar yet, ultimately, pass harmlessly overhead.

The Bank of England today announced that it will be holding the base rate of interest at its historically low level of 0.5% for another month, where it has remained since 2009. The Bank also announced that the level of economic stimulus that represents its quantitative easing programme will remain at £375 billion.

The strength of the economic recovery will be properly judged when this stimulus is removed and, similarly, the robustness of the housing market will become apparent when interest rates rise.

If the housing market is booming rather than bubbling, those who have been offered high LTV and LTI mortgages will be able to withstand the higher levels of household indebtedness they will invariably experience when the rates rise. >If not, then it could be a very rainy day for many homeowners, and the UK economy as a whole.

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