0800 358 5068

So, just 3 weeks left until Christmas as I write this and most economic commentators seem to think that the Bank of England should be offering us a Christmas present of a drop in interest rates tomorrow to acknowledge that times are tough for consumers. Generally, we support that view although, by knowing how focussed the Bank of England are on inflation, they may wait until January before offering such a gesture as it might encourage people to spend more than would be prudent prior to Christmas.

Newspapers remain full of “credit crunch” stories but, as we continue to say in the UK, where lending has been generally fairly responsible, this is not actually a credit crunch so much as a liquidity crisis brought on by the credit debacle in the US.

As a result of this, well over 1,000 jobs have been terminated by mortgage lenders since September and several lenders have effectively stopped lending. This will offer greater market shares to the remaining players but the question is how big will the market be?

If the mortgage market itself is driven by housing transactions, it will be a considerably quieter market as estate agents report far less properties coming on to the market and much reduced sales activity.

However, it would be wrong to assume because of this everybody in the UK should be worried about their mortgages and that the good times are over. Property prices will come down, interest rate margins have increased but, to counter this, interest rates themselves will fall and, at present, unemployment appears to be low so there is still an enormous demand for housing. Some surveys are suggesting that, despite official figures, the population in the UK could be higher than 70m. Consequently, housing will remain in short supply if we continue to build just 150,000 properties a year which cannot allow us to contain all the new arrivals in the UK. So, for a property investor, the long term market remains very positive even if the short term is a little rocky.

As I write this, the newspapers are writing of an apparent crises which will befall 1.5m people in 2008. A great many column inches of newspapers today have been devoted to the speech of Clive Briault of the FSA regarding the mortgage market and the potential difficulties of some borrowers over the next year.

Speeches like this can cause alarm when reported in newspapers but this is just a normal function of the mortgage market when individual interest rates increase. The only difference in 2008 is the potential lack of choice in the mortgage market as liquidity is so scarce for lenders.

The headline story was that 1.4m people were currently at the end of their fixed rates. We have often talked of “payment shock” over the last dozen years or so since interest rates came down from their previous 25-year average of around 10% to 11%.

We have been through a dozen years now of single figure mortgage rates and, therefore, small movements in actual interest rates can cause significant increases in mortgage costs when looking at a household budget. We all live on the money we have left over after our housing costs and, if our mortgage or rent increases substantially, we will experience payment shock and have to tighten our belts accordingly, or move.

Returning to Mr Briault’s points, the two most popular fixed rate periods are 2 and 5 years. Borrowers who fixed 5 years ago who got the very finest of deals will be coming to the end of a rate of around 4% – 4.25%. Borrowers who fixed at the end of 2005 for 2 years would have benefitted from rates of around 4.5%.

If these same borrowers choose to refix for the same period, they will both be looking at rates of approximately 5.5% for both 2 years and 5 years at present. This will represent an increase of interest costs of 22% for the 2-year fixer or 37% for the 5-year fixer.

On the face of it, this is a difficult pill to swallow.

But, if we look at national statistics, the average earnings over the last 5 years have increased by about 13% and, over the last 2 years, by 6%. In addition, house prices have grown by 60% since 2002 and 17% since 2005.

CML’s statistics confirm that the average first time buyer takes a 90% mortgage and that average first time buyers’ incomes have increased by considerably more than the national figures I have just quoted (33% in 5 years and 11% in the last 2).

This helps us find a way to solve borrowers’ problems. Assuming that, over the last 5 years, every pay rise has been used to support a better lifestyle, a borrower who originally borrowed £90,000 on a £100,000 property, will be looking at an increase of £112 per month in mortgage interest. In order to subsidise this increase, they could simply (given that statistics suggest their property is now worth £160,000 and their income has risen) increase their mortgage from £90,000 to £96,750 as they refinance and use this £6,570 by placing it on deposit and making a standing order back into their own bank account of £112.50 to artificially disguise the increased cost of borrowing.

When Mr Briault talks of people potentially not being able to stay in their homes due to alarming increases, we should think of the effects of this previously benign environment and consider increasing indebtedness at this point to ensure that a borrower who feels stretched on a monthly basis remain in their home and defer the problem for a further 5 years. By 2013, hopefully individual family income and circumstances will have improved and the economy stabilised and liquidity returned to the market. Of course, it is by no means ideal to increase your borrowing but, as an alternative to being forced into arrears and to potentially suffer repossession or moving to a smaller property and considering all the capital costs in such a move, in these circumstances this is a worthwhile alternative.

The situation of someone who bought 2 years ago is not quite as easy to resolve.

Their mortgage rates using the same example will increase from £337 per month to £412.50, a £75 per month increase. They will have enjoyed a 6% increase in income, taking average earnings in the UK up from £22,400 to £23,764 in that period – an increase before tax of around £113 per month – approximately £76.50 after tax and NI. So the increase in mortgage costs, should they fix for another 2 years, will be very similar to the increase in income they have received. Nonetheless, if this was a problem, through a similar exercise, borrowing £91,800 when they rearrange their mortgage, given that their property has increased by a national average of £17,000 in that period, would allow these increased costs to be defrayed.

So, it’s clear that the impact of mortgages increasing, whilst not ideal, can be easily discounted by some careful planning at this time.

If we then considered the cost of any unsecured credit which a borrower may have – credit cards, car loans, home improvement loans, etc. – it could well be that, by rescheduling those within the long term mortgage and therefore enjoying a lower interest rate, their cashflow could be substantially improved and the short term debts still wiped out quickly if required.

The only danger of these assumptions would be if property prices fall rapidly by more than 5%, thus restricting some of the flexibility which the increased house prices have given homeowners who bought 2 years ago. So, as always, borrowers should be thinking about their circumstances at least 3 months before their current mortgage rate expires and discussing the situation not just with their existing lender but also with independent mortgage brokers who have exposure to the whole market and experience of both good and bad phases of the economic cycle.

At Chase De Vere these are the sort of problems which we are addressing with clients every day and, although the FSA is correct to highlight these issues, resolving these problems satisfactorily, with our help and experience is within the grasp of most homeowners.

We will be back with a new commentary in January. In the meantime, may we offer you seasons’ greetings from Chase De Vere and wish you well in your housing in 2008 which will be an interesting market. We look forward to hearing from you and helping you.

SIMON TYLER
05.12.07