Another trick to keep UK house prices rising is taking center stage: the extra-large mortgage. It’s the mortgage lasting half a lifetime, or more, which allows you to buy a home even if, under normal circumstances, you would not afford it.
A young couple interviewed by the BBC told how they got a 40-year mortgage, instead of the usual 25-year one. Monthly payments are affordable, and they are happy.
When taking out such mortgages, not many people think about the fact that they are paying a huge price for that property. The couple in the BBC report did say that they were relying on continuing house price growth to ensure their gamble paid off.
They borrowed £300,000, and the BBC explains the attraction of the four-decade mortgage: “You pay £948 a month for a typical 25-year mortgage, but only £716 if you extend the term to 40 years.”
What about interest for the total duration of the loan? Well, “interest over 25 years adds up to around £84,000, but the total over 40 years is £144,000.”
The couple would need quite robust house price inflation to stay out of negative equity. Of course, the past 40 years have shown that, at least in London, there are huge gains to be made from property.
The problem is that believing that past performance is an indication for future performance is, as investment websites and magazines keep telling us, wrong.
The UK is now in a situation where, no matter what house prices do, they will have bad consequences for the economy.
If house price inflation continues, banks will become more and more vulnerable as they will extend many loans like that, which are vulnerable to any turn in macroeconomic conditions. Already, they’ve been expanding their lending to riskier categories, pushed by low interest rates into finding “creative” solutions.
Not just banks, but the real economy is being harmed. Buy-to-let mania has diverted money that would have otherwise been invested in the stock market, with one, two or two dozen properties almost obligatory fashion accessories for the respectable middle-class “investor.”
These are financed by interest-only mortgages, which are paid for by the monthly rent. The “investors,” just like the couple in the BBC report, rely on increases in the price of the homes to pay the principal at the end of the mortgage term.
As home prices increased and investors kept buying more homes for more money, rents have increased too. Currently, at least in London, they have reached a level where it doesn’t make sense for young professionals like teachers, nurses, doctors, or even better-paid engineers or IT specialists to move to the city, unless they are fine with sharing a flat with unknown people.
On the other hand, if house prices fall and especially if they crash, they would take the UK economy down with them. Too much of the post-crisis recovery is tied to the housing market for this to be any other way; retail sales have been rising mainly on the back of rising consumer confidence and increased borrowing due to house price inflation.
People would be pushed into defaulting on their mortgages if house prices fall, and this time there is little the Bank of England can do, short of buying every toxic asset out there. But if it does this, it would fuel a crisis of confidence that could make things worse.
The government would have little ammunition too. A population tired of bailout after bailout will sour at the thought of bailing out banks yet again, so the banks will have to repossess rather than show lenience to borrowers going through hard times. That would push house prices into a downward spiral, just as they were in an upward spiral during the bubble.
Those defaulting and being repossessed will be forced to rent in the private sector, and will probably have to rely on housing benefit. But that will create another problem.
Calculated excluding public sector banks, the UK’s budget deficit was more than £43 billion last year. The bill of around £25 billion for housing benefit represents around 58% of the deficit. It is not clear how much more the government can fork out, so probably private sector rents will have to fall.
We are, therefore, at a point where no matter what direction UK house prices go, up or down, they can only harm the economy. Stagnation would probably be the best outcome – if only the government can refrain from subsidising yet another round of buying to push prices even higher.