Bleak house


Nov 29th 2007 From the Economist Intelligence Unit ViewsWire

The worst is yet to come for Britain's housing market

The UK housing market has been slowing dramatically in recent months, and it appears that worse is yet to come. The latest data from the British Bankers' Association (BBA) show that the number of home loans plummeted by 22.4% month on month to a record low of 44,105 in October—and this marks the third successive month of decline. In year-on-year terms, loans secured on housing fell by 37.4%. In the BBA's press release, its statistics director, David Dooks, warned that the latest data provided "evidence of a rapidly slowing mortgage market".

Backing up BBA figures, Halifax reported that its house price index fell by 0.5% month on month in October, following a 0.6% decline in September. According to the latest housing market survey from the Royal Institution of Chartered Surveyors, 22.2% more chartered land surveyors had reported a drop in house prices in October, compared with 14.9% in September.

Why the turnaround from what has been a heady market? Higher interest rates have begun to limit the extent to which demand for housing can be financed. Rates have risen five times, by a total of 125 basis points, over the past 15 months. Although it is widely accepted that the Bank of England (BOE, the central bank) is about to embark upon a period of monetary loosening—whether it will cut rates as soon as December 6th remains a close call—base interest rates are not expected to fall below 5% for the foreseeable future.

UK house prices have become unaffordable to an increasing number of the population, given that household debt now exceeds 150% of disposable income (a historical high), and that the mortgage interest burden stands at 20% of gross income (up from 11% in 2003). Even if demand were strong enough to continue to push up house prices, the recent credit crunch has reduced the funds available to potential house buyers as lenders have reined in borrowing. There is also the additional expense from the extension of the controversial Home Information Packs (HIPs), which cost on average between £300 and £350, to all properties from December 14th (HIPs are currently a mandatory requirement for properties with three bedrooms or more).

Bleak outlook Increased mortgage repayments are set to deal current homeowners a further blow. According to the Council of Mortgage Lenders (CML), 1.4m people will reach the end of cheap fixed-rate loans over the next 12 months, and will then have to make higher monthly repayments.

Given the current credit squeeze, there will be few attractive offers from banks to refinance for a better deal. Indeed, many lenders have tightened their lending criteria as a result of the problems in the US subprime mortgage sector. According to a report from Moneyfacts (an independent financial research group) as of October, lenders had withdrawn 40% of buy-to-let and residential mortgage products over the past three months. In the case of “bad credit” mortgages, there was a 72% drop after rapid growth prior to the problems in the sub-prime mortgage market. According to Moneyfacts, even people with good credit ratings have suffered a 16% decline in the number of mortgage products available.

These trends will inevitably lead to an increase the number of defaults—although it is unlikely that there will be a surge in defaults to the extent witnessed in the US, where many subprime mortgage holders are being hit by higher "reset" repayment rates. Faced with higher mortgage repayments, British homeowners will be in less of a position to release their equity to purchase additional homes. This should ease demand in the currently-fast-growing buy-to-let market which has been helping drive up demand for housing in recent years.

Indeed, the CML believes that worst is yet to come. In its 2007-08 forecast for the housing and mortgage market (published in October), it noted that higher interest rates had led to year-on-year declines in the levels of first-time buyer and home-mover activity, even before the credit crunch hit in August. Given the reduced availability of credit, the CML says the housing market is set to weaken further over the following 6-9 months, even taking into account a forecast reduction in interest rates (to 5%) by mid next year.

The CML projects that the number of house sales will drop by 15% in 2008 and that house prices will rise only slightly between now and the end of 2008, as gross lending slips to £340bn in 2008 from around £360bn in 2007. At the same time, the CML predicts that increased difficulties in making mortgage payments will push up arrears and possessions. It forecasts that the number of possessions taken by first-charge mortgage lenders will increase to an estimated 30,000 this year, from 22,700 in 2006, rising further to 45,000 in 2008 (which would be the highest level of possessions since the mid-1990s).

With the ratio of home prices to earnings at a record high, lenders becoming more conservative, and employment growth set to ease, the outlook is for a more subdued housing market. Should the housing market continue to deteriorate, this will also pass through to consumer spending, given the excessive debt burden of UK consumers.

The Economist Intelligence Unit believes that the lagged effect of more restrictive monetary policy, combined with the impact of the recent credit crunch and slower employment growth will likely lead to a slowdown in household consumption over the next year. We project that private consumption growth will decelerate to 1.7% in 2008 from an estimated 2.9% in 2007. This will drag down UK GDP growth to a forecast 1.9% in 2008—compared with an estimated 3.1% this year. The possibility of a sharp downward correction in house prices could have serious negative consequences for household consumption and hence poses some downside risk to our forecast.