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Homebuyers are now at full stretch
By Sharlene Goff

Published: May 18 2007 15:53 | Last updated: May 18 2007 15:53

The relentless growth seen recently in the UK property market has not only silenced the doomsters who two years ago predicted a crash, but has eclipsed some of even the most ambitious forecasts.

Even in the face of rising interest rates, higher moving costs and huge pressure on first-time buyer affordability, property’s upward path has continued unabated.

But now, after a fourth quarter-point interest rate rise in just nine months – and another seemingly on the horizon – are the bears among the property commentators finally about to be proved right?

Property indices suggest growth had already started to cool off in the months preceding last week’s base rate rise.

Research from Nationwide, for example, showed that average house price growth between February and April fell to just 2 per cent – the lowest three-monthly increase since last August, when the recent cycle of rate rises began.

Admittedly this slowdown is not countrywide. Prices in London and the south-east, for example, have stood firm as severe housing shortages have continued to buoy prices.

But a greater split looks to be emerging between areas where property is still outperforming, and those where prices are coming under pressure.

Peter Bolton-King, chief executive of the National Association of Estate Agents, says: “We cannot expect to see a pattern across the country. In areas that still have a supply problem I don’t see interest rates making a difference at all.”

Prime locations such as London are also more immune to interest rate rises because of a high level of cash buyers and overseas investors. But other areas – such as the north-west and the East Midlands – are more vulnerable.

Richard Donnell, director of research at Hometrack, the housing information company, says: “Interest rates are already biting in areas that are more sensitive. It is hard to see how much of an impact rate rises will have on City bankers, but buyers outside London, who are more likely to be average people with average earnings, will be finding it harder.”

The four interest rate rises mean the cost of servicing an interest-only mortgage with a variable rate has risen 22 per cent since last August. Add to this house price growth of, say, 10 per cent, and the cost of getting on to the property ladder has risen by almost a third in less than a year. Fixed mortgage rates have also gone up from around 4.45 per cent to 5.3 per cent in the last year.

Buy-to-let investors, who typically pay off just the mortgage interest and take fairly high loan-to-values, will also be feeling the pinch of successive rate rises. Net rental yields have come down to as low as 3.5 per cent, meaning that landlords increasingly have to top up mortgage payments from their own pockets.

Nicholas Leeming at Propertyfinder.com says: “In isolation these small rate rises don’t make that much difference but we have now seen a full percentage-point increase, which might make some people think more carefully about what they are borrowing.”

Brokers calculate that the cost of servicing a £200,000 interest-only mortgage has risen by about £165 per month since August.

Although wages have also increased, homeowners are having to set aside a higher proportion of income to cover their mortgage.

According to figures from the Council of Mortgage Lenders, the typical homeowner is currently having to spend 17 per cent of their income on paying the interest on their mortgage, compared with 15 per cent a year ago.

This is still some way behind the levels that triggered the last property crash. From 1988 to 1990 the proportion of income typically required to cover mortgage interest rose from 17 per cent to 27 per cent.

David Stubbs, senior economist at the Royal Institute of Chartered Surveyors (Rics), says: “In terms of how much mortgage costs account for as a proportion of pay, we are a world away from the lows we saw 10 years ago. But we are still quite a way from what we saw in 1989 or 1990.”

He says that what triggered the 1990s housing crash was “massive, sudden and unexpected” rises to interest rates.

Interest rates jumped around 5 percentage points in just a few years. This meant that people were unable to adapt their spending patterns quickly enough and many failed to keep up their mortgage payments.

“Four rises in the last 12 months is significant but nothing like what we saw in the early 1990s. I don’t think it is anywhere near what is required to cause a big correction,” adds Stubbs.

Fionnuala Earley, chief economist at Nationwide, says: ”The big difference is the state of the economy. The massive interest rate rises back then meant many people lost their jobs.”

Now, however, there is a sense of confidence in the City; employment is high and wages have been rising. This, coupled with strong pent-up demand for properties, means prices are unlikely to take a serious tumble.

One concern, however, is that many property buyers – especially those who have got on to the ladder in the last year or so – now typically have higher mortgages, so are more vulnerable to smaller rate rises.

“People are more indebted than they have been before so will feel the interest rate rises,” says Earley. “Also in a low-inflation environment the debt hangs around longer.”

Ray Boulger, senior technical manager at John Charcol, says that mortgage approvals have been soft since December. “Lending figures are up but this is because the average mortgage size is about 10 per cent higher than a year ago. The actual number of loans being taken out is falling,” he says.

For first-time buyers especially, it is not just a case of affording monthly mortgage payments but also the upfront costs, which have risen sharply.

Research from Rics shows that an average buyer would now have to save up more than three quarters of one year’s salary to afford the initial cost of buying the average home.

“It is hard enough for someone to save 10 per cent,” says Stubbs. “Even if they can do this they would have to save up for seven and a half years just to meet the initial costs.”

Even if you can find the money to purchase a property, there is still the question of whether this is the right time.

Boulger says the most important consideration for people thinking about whether or not to buy now is what they think house prices will do over the next 12-18 months.

“If you think prices will go up another 10 per cent or so then that is a big incentive to buy. But if you think prices will be flat, or even fall then there is no real advantage over renting.”

Another important consideration is where you think interest rates are going. There is a consensus that there will be another quarter- point rise this year, which could signal the peak.

But, bear in mind that rate movements are unpredictable; this time last year as many – if not more – people thought rates would fall rather than rise.

Experts believe it would take a considerable jolt upwards to trigger real problems in the housing market. Some put the “danger zone” at around the 7.5-8 per cent mark, which even the most pessimistic would find unlikely.

Bolton-King says: “We would have to see interest rates going up to levels I don’t even want to think about for it to start to make a real difference to property prices.”

Copyright The Financial Times Limited 2007
http://www.ft.com/cms/s/72f97ef6-0531-11dc-b151-000b5df10621.html