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Safe as houses

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When I was young the standard dinner party line was… son… whatever you do…. get onto the property ladder.  The old adage was if you stretch yourself over time (but still only within what you can afford) inflation should eat away at the debt, coupled with house price appreciation will mean your loan to value is reduced and you will probably be able to remortgage at better, possibly lower rates.  This framework may have worked for a time when we saw positive inflation and interest rates that were coming down from double digit levels.  It seemed like a one way bet and we all experienced it and believed that as such it was true.  For quite a while house prices only moved in one direction.  Consider the position we are in now.  Interest rates at rock bottom levels and asset prices arguably at elevated levels.  What could happen now if you follow that old advice and stretch yourself when buying a property?  In the UK at the moment most mortgages are fixed for a short period of time, so it is hard to budget long term.

Imagine a situation where house prices drop by 5% over the next two years and interest rates increase.  Those home ‘owners’ that stretched themselves previously are likely to see their loan to value reduce as well as their mortgage payment increase.  This would be acutely felt in the monthly cash flows and in a rising interest rate environment where house price appreciation doesn’t materialise the notion of stretching oneself seems frankly unwise with hindsight.  They could also be in a position where they cannot remortgage because the loan to value is too high.  Maybe one should have considered more about what one needs than what one wants when buying the forever home.

Property television programs now are no longer about property developers flipping two up two downs for high double digit returns. Instead only the other night the focus changed to million pound houses that have been on the market for years and not sold.

Before considering purchasing a property one has to consider what is the future path of interest rates.  Mark Carney has got a real balancing act on his hands, and to a lesser extent so has Janet Yellen in the US.  Mr Carney realises that the UK mortgage market is pretty much predicated on two year fixed rate deals and so many of us will  have to refinance our mortgages after this time period.  In the US mortgages are generally 30 year repayment obligations (where you pay back interest and some capital at the same time) and therefore individuals are less susceptible to changes in short term interest rates.  This was one of the reasons that before 2008 the national level of US house prices had never posted a negative year.  Although we did see the horrendous outcome on the US housing market based on over-lending to those unable to sustain mortgage payments in a weak economy and a period of high unemployment.

Imagine a scenario in the UK where the average family earns £2,000 on a net basis every month. They have a mortgage of £160,000 on a property worth £325,000 (60% loan to value at 1.5% interest cost) the monthly interest-only cost is £200 (10% of their net income).  If interest rates go up by just 1.5% to 3% their interest-only mortgage payments will double and suddenly the interest-only element of their mortgage payment represents 20% of the net income and so on and that’s with just a small increase.  Mr Carney I’m sure is only too aware of the magnified effect of small changes in interest rates having large percentages impact on mortgage holders disposable income and thus the overall economy.

Property television programs now are no longer about property developers flipping two up two downs for high double digit returns. Instead only last night the focus has changed to million pound houses that have been on the market for years and not sold.

Before you all reconsider purchasing a property one has to consider what is the future path of interest rates.  Mark Carney has a hell of a balancing act to play, and to a lesser extent so does Janet Yellen in the US.  Mr Carney realises that the UK mortgage market is predicated on two year fixed rate deals and that we all have to refinance our mortgages after this time period.  In the US mortgages are generally 30 year obligations and therefore individuals are less susceptible to changes in short term interest rates.  This was one of the reasons that before 2008 the national level of US house prices had never posted a negative year. 

Imagine a scenario in the UK where the average family earns £2,000 on a net basis every month. They have a mortgage of £160,000 on a property worth £325,000 (60% loan to value at 1.5% interest cost) the monthly interest cost is £200.  If interest rates go up by 1.5% (i.e. to 2% plus 1% spread = 3%) and house prices fall by 5% and they have to move to the standard variable rate and as such can borrow at 5% their monthly interest costs now move to £666.  This is over a 200% increase in their mortgage payments and now servicing the mortgage is 33% of the families disposable income.  Not-forgetting this is just the interest part and forgetting about the additional cost of paying down the principal.  Mr Carney is only too aware of the magnified effect of small changes in interest rates having large percentages impact on mortgage holders disposable income.  As such he might act slower and lower rates are here to stay for longer than previously expected – or am I just talking up my own book as I have just purchased a mortgage/house?

 


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