The biggest threat to house prices – rising lending costs

published 6 March 2012

House prices fell by 0.5% during February, according to the Halifax. That leaves prices down 1.9% on the same time last year.

The average UK house price is now £160,118. Judging by Halifax's figures, that's nearly 20% below the August 2007 peak of just under £200,000. That's quite a fall throw in inflation, and it's even more significant.

Yet it might not feel like that to anyone who had hoped to buy a home post-bubble. With sales low, sellers reluctant to move, and home loans hard to come by, the housing market hasn't so much crashed as been put in the deep freeze.

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But something else that the Halifax announced earlier this week just might help to thaw the market out.

Why are mortgage rates ticking higher?

Halifax is raising its standard variable rate (SVR) to 3.99% from 3.5% on 1 May. That doesn't sound like much. And in the big scheme of things it isn't. It's about £40 a month extra on a £150,000 repayment mortgage. According to thisismoney.co.uk, roughly 850,000 borrowers will see their payments rise.

But Halifax isn't the only one; Santander and RBS/Natwest have raised some of their rates too.

And what's significant here - for now at least - isn't the amount of money we're talking about. It's the direction of the rate change.

After all, the Bank of England rate hasn't altered. It's still 0.5%. In fact, the Bank's most recent move was to loosen monetary policy further, via another bout of quantitative easing.

The Bank is also sanguine about inflation. There's no sign of any desire on its part to put rates up any time soon. So what are Halifax and its rivals up to?

Well, this is where we have to remind ourselves that it's not actually the Bank of England rate that matters when it comes to how much banks charge you to borrow money.

At its most basic level, a bank gets money from one place at one price, and lends it out at another, higher price. If the banks' funding costs are rising, then what they charge us will rise too.

It has become more expensive for banks to raise money in the wholesale markets in recent months (although it's eased off in recent weeks). It's also getting more expensive to raise money from savers. Fed up with inflation eating their cash savings, people are increasingly investing, rather than saving.

That's risky of course, but it's a direct result of Bank of England policy people are doing what the Bank wants them to do. The trouble is, once savers have made that psychological jump, it means banks have to work harder to attract them back.

How will this affect the housing market?

But it's not just higher funding costs. That makes it sound as though the banks are poor wee things, subject to the whims of the cruel money markets. They are just "passing on costs", is how they sell it.

Nonsense. Banks have to make a profit too. And the fact is that Halifax had one of the lower SVRs. This move merely brings it more in line with its rivals. So it makes sense from the bank's point of view at least to improve its margins where the market will bear it.

Also, as I've mentioned already, this is all part of the banking sector's attempts to return to business as usual'. We've already seen lenders cracking down on interest-only home loans. Now we're seeing them tighten up on SVRs.

The fact is, banks are taking advantage of a lull to make life that bit harder for marginal customers. Some people will have stayed with the SVR because at 3.5%, it's reasonable value. They'll go elsewhere. But others will have stuck with it because they can't really afford to go anywhere else. Perhaps they're in negative equity, or perhaps no one else will have them.

Even with a rise in rates as small as this one, as Ed Stansfield of Capital Economics points out, "some reports suggest that as many as one-in-six borrowers regularly have problems meeting their payments. So for some this could be the final straw especially if unemployment continues to rise."

In 2011 there were just over 36,000 repossessions, the lowest level since 2007. I suspect that will start to rise again in 2012. As Stansfield puts it, "expect further house price falls this year."

This article is taken from the free investment email Money Morning. Sign up to Money Morning here .

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John Stepek is a senior reporter at Bloomberg News and a former editor of MoneyWeek magazine. He graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.

He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news.

His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.