The timebomb under Britain’s property market

Britain's house prices have so far avoided an all-out crash. But as banks begin to raise mortgage rates, we could soon see property prices falling further, says John Stepek.

The British housing market has suffered a very unsatisfying sort of crash.

Depending on which set of data you use, house prices for Britain as a whole are down by around 10-20% on the peak in 2007.

But a lot depends on where you live. Certain parts of London are now more expensive than they were back then. And other parts of Britain are significantly cheaper.

Subscribe to MoneyWeek

Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE

Get 6 issues free

Sign up to Money Morning

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Sign up

House price falls aren't great news for those who were living in those properties, of course. But prices haven't dropped far enough to satisfy the bears either. Combined with tight credit, prices remain far too high for your average first-time buyer.

Will that change in 2012? A report from S&P suggests that it could and that prices could fall further

The north of England is facing a bigger squeeze than the south

You might have thought, that around four years on from the credit crunch, the UK property market would be getting healthier. According to credit rating agency S&P, you'd be wrong.

In the last quarter of 2011, 5.6% of borrowers were in negative equity. In other words, the loans on their homes were worth more than the properties themselves. That's deteriorated since the second quarter of 2010, when only 3.6% of homes were in negative equity.

As the FT points out, the figure is far worse in the north of England, where 8.5% - not far off one in ten homeowners is in negative equity.

What does this mean? To S&P, it means that homeowners could come under a lot more pressure in 2012.

Falling home equity is "a statistically significant predictor of arrears and defaults". In other words, the more over-leveraged people become, the more likely it is that they won't be able to pay their mortgage.

The problem isn't negative equity as such. As long as you can keep making your monthly payments, it doesn't really matter what the theoretical paper value of your home is.

The real problem is that when homeowners have little or no equity in their homes, this "tends to limit their ability to refinance, or to sell the securing property, to clear the [home loan]", says S&P.

That's because if your loan-to-value is high (or above 100%, as someone in negative equity would be), then banks don't want to lend you any money. So you end up being stuck on your lender's standard variable rate at best. And as we all know, these have been rising recently.

That's bad news, because the proportion of loans "worth 90% or more of the value of the property" rose to 16.6% from 13.5% in 2010's second quarter. As a result, "more borrowers could therefore come under financial stress in 2012", particularly if unemployment picks up.

The interest-only timebomb

Worse still for squeezed homeowners, it looks as though rates which have supported troubled borrowers so far are going higher.

Unquestionably, the main thing that has propped the housing market upis the Bank of England's interest-rate slashing. That's what has kept repossessions relatively low during this housing downturn. Repossessions peaked at 48,300 per year in 2009, a far cry from the 75,000 seen in 1991, during the last crash.

But even though the Bank has kept its rate at 0.5% for more than three years now, lenders don't seem to be planning a similar freeze in their rates.

According to, the average rate for a two-year fixed-rate mortgage fell to a low of 3.82% in October 2011. Now it's gone up to 4.15%. That's not a huge jump, but as we've noted before, it's the direction that matters.

It's also worth remembering that there are a lot of homeowners out there who are extremely vulnerable to any sort of rise in rates. More than a third of home loans outstanding in the UK are written on an interest-only basis.

Some of those a minority, I'd wager have a sensible plan backing them to repay the capital. But an awful lot of them won't. At the peak of the market, interest-only loans accounted for about one in every three new home loans.

Martin Wheatley of the Financial Services Authority recently described this as a "ticking timebomb". It's a pretty punchy description for a regulator, but it doesn't seem far wrong.

Why were those people taking out such loans? Probably because they couldn't afford the payments on a traditional repayment loan. In other words, they overstretched themselves at the peak of the market, and will now be stuffed if the cost of the loan rises significantly.

Trouble is, it's now becoming increasingly difficult to get hold of interest-only loans. Most banks have changed their criteria so that you need huge amounts of equity in your home before they'll consider lending to you on this basis.

So the people who took out interest-only loans at the top of the market are in real trouble. They couldn't afford the home in the first place. That's why they went for interest-only. Now it's probably worth less than they paid for it.

Meanwhile, home loan costs are ticking higher, and they don't have enough equity in their homes to qualify for any decent deals. As the Financial Services Authority puts it, they are mortgage prisoners'. So one way or another, they are facing rising monthly payments.

For all that banks and lenders make comforting noises and say that they're alert to the needs of their customers, the fact is that they'll offload as many troubled borrowers as their balance sheets will allow. And that could lead to a further slide in prices.

This threat of another drop in house prices is one reason why I'm still very wary of the banking sector, particularly our state-owned banks, Lloyds and RBS. As for the property market buying a property to live in is a personal decision, and about more than just money. But if you're looking to invest, we think the US is a better bet just now.

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

How to profit as markets panic over Spain

Merryn Somerset Webb explains where her own money is invested now, where it isn't, and where she's hoping to put it next.

FirstGroup is in trouble but it might be worth a punt

Shares in FirstGroup have tumbled since the company issued a profit warning. But it might just be a buy for the brave, says Phil Oakley.

John Stepek

John is the executive editor of MoneyWeek and writes our daily investment email, Money Morning. John 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. John joined MoneyWeek in 2005.

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.