House price growth is accelerating in the UK and the rest of Europe, but it is far from healthy growth. The consequences of lax rules on lending to house buyers could be devastating.
Perhaps the clearest example of why the increase in house prices is unhealthy is the UK. A stamp duty holiday for home buyers that was initially scheduled to end at the end of March was extended, but it still meant that people rushed to buy to beat the deadline.
Hot on its heels came another subsidy for house price inflation: the government’s guarantee for mortgages for those with low deposits, to push the banks to lend as much as 95% of a property’s price.
Year-on-year house price growth was 8.6% in the UK at the end of February, with the average property now valued at £250,341, according to the Office for National Statistics (ONS).
London was the region that saw the slowest increase, of around 4.6% — probably as people who can work from home move out to gain more space — but the average property price in the capital is £496,269.
In the European Union, house prices increased last year by more than at any other time in the past decade.
That’s despite the fact that economies spent much of 2020 in lockdown and unemployment increased, as European rating agency Scope Ratings remarked in a recently released note on house prices.
In the fourth quarter of last year, average European house prices rose by 2% from the third quarter, while the annual increase was 6.2% — twice the annual growth rate of the last decade, according to Scope Ratings.
These impressive jumps in home prices are in no way justified by economic fundamentals. While it is true that government schemes have protected the incomes of many people during the pandemic, uncertainty about future income is running high.
Yes, some people moved to the suburbs from town centres or even to the countryside to enjoy more space and possibly a garden as the pandemic has made working from home acceptable.
And yes, tenants have been kept in their homes by government schemes that sought to protect people from being evicted and ending up homeless, spreading deadly germs around while seeking new accommodation.
But the biggest drivers for the jump in house prices have been central banks. In the eurozone, the European Central Bank’s main interest rate is negative. In the UK, it is barely above zero. Plus, central banks are hoovering up debt assets like they’re going out of fashion.
In such an environment, refraining from taking on a mortgage has almost become a marker of strength of character.
When the music stops
However, this euphoria could end badly for the borrowers and consequently for the banks. The NINJA loans (no income, no job, no assets) loans of the great financial crisis more than a decade ago are just a distant memory — but they really should focus the regulators’ minds.
The financial crisis happened because too many of these loans were given to people who, when house prices stopped rising, found themselves unable to pay their mortgages.
This time, the crisis could be worse if it starts in Europe, because in Europe unlike in the US, mortgages are generally full recourse.
If a home buyer can no longer pay their mortgage, the bank has the right not only to repossess the home but, if it cannot sell it for a price that covers the rest of the debt, can pursue the former homeowner for the difference.
This means a recession following a housing market collapse would be deeper and more protracted, as people would be saddled with debt for years afterwards.
Over the short term, house price growth could persist or even accelerate in Europe, as housing supply is likely to remain tight with construction activity hampered by the ongoing Covid-19 pandemic, according to Scope Ratings.
But, the rating agency’s report adds, “with household income and rents only increasing very moderately during the last year, we see increased pressure on housing affordability and profitability.
This may be the right time for regulators to become proactive and introduce stricter macroprudential measures, else banks and borrowers might be caught on the wrong foot when the tide turns.”
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