Buy-to-let: the market’s Achilles heel

The UK housing market is now dominated by buy-to-let investors. But a combination of rising interest rates and falling yields could make many investors' positions untenable, says James Ferguson.

House prices in the UK have looked like a classic bubble for some time now. I first warned on this for MoneyWeek three years ago because affordability looked dangerously stretched. Since then prices have risen 18%, according to Nationwide. But as the dot.com bubble showed, once prices are unsustainably high, they can always run further before the final trigger that causes the crash. What we're seeing now in the credit markets could be that trigger. The credit market turmoil may seem esoteric to the man in the street but mortgage rates aren't just down to the Bank of England base rate. Northern Rock for example, sources more than 75% of its funds through the wholesale market, where the spread (or premium) over LIBOR (the London Inter-Bank Offer Rate) has gone from as low as 0.1% in January to more than 0.6% now. That is equal to another half-a-percent rate rise in its cost of funding, that will have to be added on top of the 0.75% rise in base rates since the start of the year.

Gone are the days when borrowers could expect to pay a small, or even zero, premium over base rates for their mortgage. As credit spreads normalise to reflect the true risks lenders are taking, even the best mortgage rates will now need to be 0.5% higher than base rates. If base rates do indeed rise to 6% and spreads do rise to 0.5% over that, a standard 25-year repayment rate would be equivalent to 8.1%. On the average UK first-time buyer's house price of £164,000, and assuming a £25,000 deposit, that'd now be £938 a month.

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James Ferguson qualified with an MA (Hons) in economics from Edinburgh University in 1985. For the last 21 years he has had a high-powered career in institutional stock broking, specialising in equities, working for Nomura, Robert Fleming, SBC Warburg, Dresdner Kleinwort Wasserstein and Mitsubishi Securities.