I am being endlessly told by the chancellor and the bank of england that there is no housing bubble, all the fears of one are totally unfounded. However I can’t help but feel that the reaction of the press, economists and former politicians rubs against this view whilst at the same time feeling something simply doesn’t feel right with it all. I appreciate that statement is somewhat ambiguous but allow me explain two things that make me very uneasy.

 Help To Buy

in the 2013 budget, George Osbourne announced the extension of the “help to buy” scheme. This extension moved away from just new build properties to provide the government help for any property up to the value of £600,000 which is over twice the national average for a home right now (?).

“We’re going to help families who want a mortgage for any home they’re buying, old or new, but who cannot begin to afford the kind of deposits being demanded today.”

George Osbourne, Chancellor of the Exchequer

But how does “help to buy” work?

Firstly you’ll need to contribute at least 5% of the property price as a deposit. Fair enough, that is the point after all!
Next the government will give you a loan for up to 20% of the properties price and then you need a standard mortgage of up to 75% to cover the rest of the cost. All very straight forward and I am sure you’re all aware of that information, so lets dig a little deeper.

The government will lend you the money interest free for 5 years after which they will charge you 1.75% interest on the value of the loan. However, that fee will increase each subsequent year by the retail price index plus 1%. In October 2013 the RPI stood at 1.9% so on that basis you will be paying 4.65% on the cost of the loan. That means if you borrow £40,000 from the government then in year 6/7 you will owe an extra £1,860 a year to the government.

Probably best to pay that £40,000 off in the first 5 years but that is £666.66 per month (see how many consecutive 6’s there are) on top of your mortgage, energy bills, food and the odd cheeky glass of wine. Beside that, you can only pay back either 10% or 20% or the total amount, so long as the loan is worth at least 10% of the value of your home.

So now this “Help to Buy” has an ever increasing interest rate and an additional burden on your income and that’s even before the interest rates have moved. It’s really a elaborate case of buy now, pay later.

It’s not sounding so “helpful” now is it?

 

Interest Rates

Uk Interest Rates

The big decider in this is indeed this very subject and as you can see from the chart we are at an all time low of 0.5%. The very sawtooth nature of this chart should be a warning that interest rates always fall and rise, there isn’t exactly much room for them to fall further either. As in the 1980s classic Yazz chart hit, the only way is up!

On the 7th August appearing on Channel 4 news Mr Carney said this of the Bank of Englands interest rate policy:

“We do not intend even to consider raising it before unemployment falls to 7 per cent.”

Mark Carney, Governor of the Bank of England

Recent unemployment official figures have showed the unemployment rate fell to 7.6 per cent in the three months to September, down from 7.8 per cent. That is the lowest figure in 3 years and if it continues to fall at that rate we will hit 7% very quickly indeed.

So it appears that Mr Carney recently softened his language:

“We will not even begin to think about moving interest rates until that threshold is achieved and when it is achieved it will be a question of how much momentum the economy has and its ability to withstand an adjustment in monetary policy”

Mark Carney, Governor of the Bank of England

Now maybe it’s just me, but I smell a rat! No-one in Whitehall or the Bank of England seems to want interest rates to rise until the third or fourth quarter of 2015.

That is after the 7th May 2015 which is, of course, general election day…

 

In Conclusion

Bubble Bursts

The key to the housing bubble bursting is interest rates, that is the trigger mechanism. It would appear the market was well on the road to resetting itself but the coalition government would never be able to stand a housing crash this late in their term. It seems somewhat ironic that Mr Osbourne, who was outraged by the Libor scandal in the city (where banks manipulated the market in the name of profit), seems to be fine with the treasury manipulating and inflating the housing market using “help to buy” which is really kind of the same thing – market meddling.

Anyway, people are funny, this is a global thing, but people are funny. There’s a perceived wealth in the ownership of property, with some homeowners obsessively checking how much the house three doors down went for. It makes them feel good, they feel wealthy when they discover it’s £50,000 more than the last one sold for. Prices are going up and they are beneficiaries of this property windfall. The only issue with this thinking is that if you actually sell your home then you will – by logic – have to buy another one. Homes are where you live after all. Now they’re buying at market value meaning their perceived wealth is significantly reduced by the reality of overpriced housing stock.

Hence help to buy is extended and interest rates are kept low so that come the next election this perceived sense of wealth is retained. I suspect this will be followed by, whomever may win, a hike in interest rates towards the normal 4-5% level which will cripple those on help to buy as well as every other homeowner in the country and creating negative equity all over the place.

As the cost of servicing a mortgage increases you’ll start to see the buy to let sector try to cover their costs, rents will start to rise and tenants will begin to be thin on the ground. That or they will liquidate their asset/s and put the properties up for sale. At the same time some of those struggling to pay will give up and sell, whilst mortgage defaulters have their homes repossessed and the banks will put these properties on to the market in order to recoup their losses. Once we add in the pensioners with the “Great Cash Out” selling their homes to pay for their care costs we should see UK property stock increase making prices compete aggressively – followed by a housing bubble burst in pretty spectacular manner.

So keep your eye on interest rates, that is the trigger for affordable housing and after all – interest rates ALWAYS go up in the end.

  • Joe

    I agree with most of this.

    One question:

    “… rents will start to rise and tenants will begin to be thin on the ground.”

    Why will tenants begin to be thin on the ground? Renters still need somewhere to live, right?

  • Generation Rent

    The suggestion would be that they would be able to buy once falling prices begin to take hold Joe. A lot of renters can afford to buy at reasonable prices and would snap up some of the repossession bargains to be had.

    • Tenant 59

      We could afford to buy if we weren’t forced to rent but renting leaves us so little ‘disposable’ income, relative to the total, that it is impossible even to save enough money to move elsewhere, let alone the deposit on a house.

  • Tenant 59

    There will be a great deal of trouble in the short-term as tenants are effectively evicted from ‘buy to let’ properties so that they can be sold, perhaps below market value, when the mortgages become unserviceable.

  • Generation Rent

    We totally agree. When the shakedown comes it will be pain all round in the short term, hopefully that will lead to a more positive outcome long term.

  • makebtlhistory

    But there is a fault in this logic. Why would anyone raise rates to 4-5%? This would increase the interest on government debt and the government likes low interest rates because it means they can inflate away the debt. Why would they willingly increase rates? Only the market can do that.

    The Tories might increase rates slightly just before the election as a sort of scorched earth present to Labour if they think they are definitely going to lose (most likely scenario), so Labour are left with a collapsing housing market and few ideas left to pull out of the hat to prop it up. I am sure Labour would try to prop it up just as much as the Tories have, after all, it was Brown who bailed out the banks. Plus ça change, plus c’est la même chose!

  • generationrent

    Why would anyone raise rates to 4-5% you ask. Well, because interest rates are currently the lowest they have ever been and that is precisely for the reasons you mention. Cheaper debt for the government. However that pressure will ease over time and if inflation begins to pick up then the blunt instrument of higher rates will be used to curb it. Short term your statement is perfectly correct however long term interest rates always go up. They where once at 14% and one day in the future will probably go there again.