The time-bomb ticking under Britain’s house prices

Last week, one dull-looking number emerged that might have a profound effect on UK monetary policy. It came from Legal & General and it is this: around 90% of all mortgages held in the UK come with a variable rather than a fixed rate of interest. That’s up from 60% in 2007.

You can understand why this might be. The best five-year fixed-rate mortgages on the market cost 4.5%. But the best variable rate mortgages come in at as little as 2%. On a 20-year repayment mortgage of £150,000, that makes a difference of £200 a month.

So, it makes sense that most people choose the cheaper looking option. You might hope, however, that those who choose such risk over certainty do so knowingly, having run through the risks they will face if the UK base rate rises from its 340-year low of 0.5% to something that is more of a reflection of our inflation rate.

But you would hope in vain if a survey from Shelter is to be believed: it says one in four mortgage holders has no idea what the UK base rate is.

Either way, the idea that 90% of mortgage holders will be hit by rate rises matters.

Why? Because while there is some evidence that there might be some kind of UK recovery under way (JP Morgan is claiming to see a mini boom in UK manufacturing), the housing market remains a miserable husk of its former self. Prices are down 15% or so from their peaks in nominal terms and a good 20%-plus in inflation-adjusted terms, while every leading indicator suggests that the falls have only just begun.

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First, look at affordability ratios. These are disregarded by bulls as being irrelevant in the days of dual-earning households and ultra-low rates. However, it is dangerous to dismiss historical norms as irrelevant. The long-term average house price to salary ratio is something in the region of three and a half to four times. Today, depending on whom you listen to, it is around five and a half to six times.

That’s the kind of disparity that can only be resolved by one of two things: rising real incomes or falling real house prices. Resolution isn’t coming from the former – the retail price index is running at 5.1%, but wage settlements were a mere 2.8% in the three months to January. That leaves the latter.

Anyone in any real doubt that this will happen (and there are still bulls out there) need only look at all the numbers that house prices tend to track.

There is net mortgage lending growth. December numbers showed that at just 1.4%. Then there are mortgage approvals. These are now around 45,000 a month, down from nearly 130,000 a month in 2006.

Next up is consumer confidence – something house prices have always followed very carefully. This is looking pretty ropey both statistically (the GfK Consumer Confidence is at its lowest since March 2009) and anecdotally.

In the name of research, I spent much of the last week standing on cold street corners asking passers-by about their debt: every single person I spoke to was either out of debt and never touching it again or desperately trying to get rid of what they had. On Monday, it took me the entire morning just to find someone who actually still used their overdraft facility. No confidence there.

Finally, note the disappearance of first-time buyers. There are 90% fewer of them than there were at the height of the bubble and their average age is now 37.

We hear much about the return of 90% and 95% mortgages. But I have yet to hear of a first-time buyer who has managed to persuade a bank to give them one.

That means there is still no demand at the bottom of the market and explains, I should think, why housing expert Henry Pryor is predicting that only one in three of the houses currently on the market will sell this year.

All this suggests that something will soon push the market over the edge.

That something could be the first interest rate rise. According to Legal & General Investment Management, a rise in the base rate and hence in variable mortgage rates will mean that huge numbers of consumers will see “a meaningful impact to their cash flow”.

Shelter goes further. The Bank of England hasn’t raised rates for 25 months, but when it does, says the charity, it could push those assuming that low rates are forever into a “spiral of debt and repossession”.

That really wouldn’t help the bull case for house prices much.

It is also why Mervyn King is doing all he can to resist a rate rise.

• This article was first published in the Financial Times