Why housing wealth is an illusion

Halifax has just reported the biggest monthly fall in UK house prices in nearly six years. And yet UK consumers are still borrowing money against their homes like there's no tomorrow. John Stepek explains why only two groups really benefit from rising house prices - retired people and the Government...

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"UK house prices go into reverse" was the BBC's sober take on the news that house prices slid 1.2% in June, the biggest fall in nearly four years.

"Shock fall in UK house priceswith further falls expected to come," shouted the Times, rather more excitedly.

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Good thing the Bank of England decided to keep interest rates on hold yesterday...

The shock' news gripping property pundits was the Halifax survey revealing that UK house prices fell by 1.2% in June. That was the biggest fall since December 2002, and came hot on the heels of a near-flat 0.1% rise in May.

The annual rate of house price growth still gained, rising to 9.4% from 9.1% in May. But even Halifax pointed out that this was due to the extent of last year's slowdown, and nothing to get excited about.

The sharp fall may help the Bank of England to feel justified in its decision to keep interest rates on hold at 4.5% yesterday. But another piece of data will have been of more concern to governor Mervyn King and his colleagues on the rate-setting Monetary Policy Committee.

The UK consumer returned to using their homes as cash machines in the first few months of the year, after a sharp slowdown in 2005. Mortgage equity withdrawal (MEW) in the first quarter of 2006 rose to £12.5bn. That's nearly double the £6.5bn taken out the year before.

Actually, the cash machine analogy is wrong. What people are really doing is using their homes as giant credit cards. Let me explain.

What some homeowners seem to have difficulty realising is that equity in your house isn't anything like cash in the bank. The equity' is based on an estimate of a value which may or may not be accurate. The only way you can find out how much equity is actually in your house is to sell it.

As Mervyn King himself once said: "House prices are a matter of opinion whereas debt is real."

And if you sell your home, where are you supposed to live? A bigger house will just cost more than the one you've sold. So if you want to have cash left over, you have the choice of selling and downgrading to a smaller home, or a bigger one in a less pleasant location - or renting, of course. This is one form of mortgage equity withdrawal, and the only one that gives you real money in the bank.

So the largest group of people who actually benefit from the housing boom are retirees. As they step off the housing ladder, they enjoy a massive transfer of wealth from the people below them. They get a lump sum property bonus on top of any savings and pension plans theyve been able to put in place during their working lives.

Meanwhile, at the bottom of the ladder, first-time buyers have to take on record amounts of debt. Any money they could be saving for the future goes instead towards saving for a deposit, and then paying their undoubtedly huge monthly mortgage bill.

And in the middle, people who are trading up have to give all the money their house has earned' to the people whose home they are buying.

So those who are still stuck on the property ladder are getting no richer - it's just their houses are getting more expensive.

The other group who benefits of course, is the government. Higher house prices mean more taxes for Gordon Brown and chums - the Treasury raked in £5.5bn in stamp duty in the 2004/05 financial year, more than eight times what it made in 1996/97. And then there's inheritance tax - the IHT take on property has more than doubled to £1.1bn from £480m in 1997. So in fact, your typical homebuyer is actually poorer for rising prices.

But people feel richer. After all, the Halifax says that something they bought for £100,000 four years ago is now worth £200,000. Who wouldn't feel richer?

And this is where the other main type of MEW comes in. This type of MEW - the one where a bank agrees to lend you money based on the fact that your property is thought to be worth more than the debts you already have secured against it - is just a loan.

You might get better terms and a larger credit limit than if you borrowed using a credit card, but in all other respects it's exactly the same. Except of course, that if you don't pay up in time, the lender gets to keep your house.

Companies try to pull the wool over consumers' eyes by using phrases like "unlock the equity in your home". But this is nonsense.

What they should say is: "We're willing to give you a large sum of money at low rates because if you end up being unable to pay it, we can take your house and sell it for a massive profit."

In that case, the only one unlocking the equity' in what was once your home is the lender.

Debt is debt, whether it's sitting on a credit card or secured against the ever-increasing price of your home. If you borrow money to buy something today that you can't afford with your present income and savings, then you are choosing to sacrifice some of tomorrow's earnings.

Given that the future has a habit of being unpredictable, we believe it's generally wiser to save up today, and hope that you can afford what you want tomorrow.

That way, when more 'shock falls' in house prices come along, you'll not be left sitting on a pile of negative equity.

Turning to the stock markets...

The FTSE 100 made gains, rising 63 points at 5,890 on Thursday. The main riser was Shire Pharmaceuticals, gaining 3% to 803p on reheated bid rumours. For a full market report, see: London market close.

Over in continental Europe, the Paris Cac 40 rose 45 points to 4,966, while the German Dax gained 69 to close at 5,695.

Across the Atlantic, US stocks made gains as the US services sector grew at a slower pace than expected, easing interest rate fears. The Dow Jones Industrial Average gained 73 to 11,225, while the S&P 500 closed 3 points higher at 1,274. The tech-heavy Nasdaq rose 2 to 2,153.

In Asia, the Nikkei 225 fell 13 points to 15,307. Exporters were once again among the main fallers on reports of a slowdown in the US service sector.

This morning, oil was lower in New York, trading at around $74.95 a barrel. Brent crude was also a little lower, trading at around $73.80.

Meanwhile, spot gold was down slightly, trading at $632. Silver was higher, trading at around $11.49 an ounce.

And in the UK this morning, insurer Aviva reports it is in talks to buy US insurer AmerUs Group.

And our two recommended articles for today...

Is the Eastern European property bubble set to pop?

- Unscrupulous and unregulated property agents in Eastern Europe are making exaggerated claims about capital gains and rental returns on homes in the region. And yet investors in Britain and Ireland seem content to continue to pour their money into places like Bulgaria and Romania. MoneyWeek's Jody Clarke explains why investors shouldn't believe the hype - click here for more: Is the Eastern European property bubble set to pop?

What will a dollar slump mean for gold?

- The pressure on the US dollar is increasing, despite rising interest rates - and that's good news for gold, says veteran gold commentator Paul van Eeden. To find out how much further the dollar has to fall - and how high gold could climb - click here: What will a dollar slump mean for gold?

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.