London property is in a bubble.
Prices are now well above their pre-crisis peaks. They are also at their highest level, compared to the earnings of first-time buyers, since records began.
Yet people are not just willing, but queuing up, to pay these inflated values.
There are some good reasons for that. Low interest rates have driven down the price of mortgages. Taxpayer guarantees through the Help to Buy scheme encourage more lending. Overseas investors see London as a safe haven. And there is a genuine shortage of property – though developments are now springing up thick and fast.
But there’s also an element of blind panic. First-time buyers are seeing their chances of ever mounting the property ladder fade. So they are snapping up any house or flat, irrespective of whether they can really afford it. I’d also guess that many people who didn’t buy last year are kicking themselves.
However, there is a big change coming that could upset everything – and it kicks in from tomorrow…
It’s going to be a lot trickier to get a mortgage
In 2009 Britain’s financial watchdog (now the Financial Conduct Authority) concluded in a discussion paper that the mortgage market needed reform. It eventually published new rules – the Mortgage Market Review (MMR) – in 2012. These rules come into effect from tomorrow.
The big change is that lenders will have to make absolutely sure that a borrower can afford the loan. Details of what exactly counts as ‘affordability’ are deliberately vague. But the regulator has given guidance, which involves looking at spending patterns and sources of income.
There is also an obligation to ‘stress test’ the loan. In other words, the borrower will need to be able to afford payments even if interest rates rise. The upshot is that most people will find getting a mortgage trickier.
Unsurprisingly, lenders have been up in arms. Given their role in the financial crisis, you probably think they’ve got a cheek to complain, and you’d probably be right.
That said, the vague scope of the rules could lead to a legal nightmare. It’s easy to imagine a scenario where banks are sued by homebuyers for allowing them to take out more than they can afford.
The government could also use it as an excuse to renege on Help-to-Buy promises in the event of a crash. After all, US banks (rightly so) ended up having to repay insurance payouts from Fannie and Freddie on loans with shoddy lending standards.
In any case, it seems that lenders are taking the MMR very seriously indeed. There have been reports of banks telling their staff to refuse loans if the borrower has the occasional flutter on the horses, or is a member of a wine club.
Some are asking for detailed banking statements over a much longer period than the usual three months. People will also be required to make predictions about the future. For instance, Barclays has said that it will require disclosure of details of future renovations. Those who lie about future spending could face having their loans revoked, or the interest rates changed.
When the crash comes, it will be brutal
Anecdotal evidence suggests that a handful of banks have already started applying the rules. The latest figures from the Bank of England suggest that the MMR could already be starting to have an effect.
After rising for 11 straight months, the amount of mortgage lending (for house purchases) fell by over 8% to £70.3bn in February. This is the lowest figure since October. Meanwhile, remortgaging activity fell by 14% in March, according to the Council of Mortgage Lenders.
At some point this bubble has to end. More houses are being built, reducing any physical shortage that actually exists. The Bank of England may or may not raise interest rates soon, but already fixed-term mortgage rates are rising.
There have been hints that the most toxic part of the Help-to-Buy scheme could be wound up after the election, whoever wins. Above all, old-fashioned reversion to the mean (prices returning to more normal levels) will also play a part.
My guess is that the government would be happy to keep the bubble going until election day. It could then let the market deflate. However, if the MMR means that banks really dial back mortgage lending, it could end up happen even sooner than George Osborne hopes.
When it does take place, the crash could be brutal. To go back to the average price/earnings ratio over the last decade, Greater London prices would have to fall by around 18%. If it went back to the average since records began, they would fall by nearly 40%.
Of course, with more and more people expressing irritation with the property-centric nature of our economy, perhaps a slump wouldn’t be quite the vote loser it once was. But I suspect Osborne isn’t keen to test that hypothesis out.
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