Do we face an interest-only mortgage timebomb?
Growing numbers of borrowers are taking out interest-only mortgages with nothing in place to repay the capital sum. This is yet another example of how the current boom is soaring up huge problems for the future.
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At MoneyWeek, we sometimes think we write about property too much. We worry that it's turning into a hobbyhorse; that we could be in danger of turning into one of those people who backs you into a corner at a party and starts lecturing you about railway privatisation or some other pet peeve. So today, I resolved to write nothing about property.
Instead, I planned to focus on the latest news about the UK economy. It's extremely mixed and strongly suggests that the times of plenty we're enjoying may be coming to a close. Or, to put it another way, that Gordon Brown's house of cards may soon be tumbling down.
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But then I spotted a story that I couldn't pass over, since it is such a good illustration of why we think that the current boom is storing up enormous problems for the future. So first, let's take the hobbyhorse out for one more morning gallop before a look at the state of the economy puts it (and us) right off its oats.
In the Guardian, John Caine reports on the growing number of borrowers taking out interest-only mortgages without having anything in place to repay the capital sum they owe at the end of the mortgage term. The exact number is not known, as it also includes many who originally took out repayment vehicles and subsequently let them lapse, but it's reckoned to be in the hundreds of thousands.
But why are people taking out unbacked interest-only mortgages? There are two obvious reasons why a buyer might do this. Both could be sound in the right circumstances, but both carry risks.
The first is for a buy-to-let investor who plans to sell the property at or before the end of the term. As a result, the investor is banking on the property being at least as valuable and hopefully more so when he or she comes to sell.
With a long-term view this should be true, but property is a highly-cyclical asset class and there is a real risk some investors who buy at the peak will find themselves forced to sell during the troughs. Their property may then be worth less than their mortgage, leaving them with what could be a very substantial shortfall. The big concern that MoneyWeek has with the growth of buy-to-let is that there are too many amateurs rushing into the industry who don't understand risks like these.
The other is for the first-time buyer, who can't afford to make the payments on a repayment mortgage but expects to be earning more in a few years' time. Again, this can make sense, but the buyer needs to switch to making repayments as soon as possible.
Human nature being what it is, people tend to put off things like that, but delaying too long could mean a very unpleasant surprise. Britannia Building Society calculates that if a buyer were rash enough to leave it until only 10 years of a 25-year mortgage remain, the payments would have to more than double if the buyer were to pay off the capital sum in time. This is obviously an extreme case and hopefully there won't be many people in this position.
Of course, some people may be investing to pay off the mortgage, but are not using conventional vehicles such as endowment policies. Given the mis-selling scandals and poor performance attached to many of these in recent years, that's quite understandable.
But some investment ideas are clearly better than others. I'm alarmed by a new product from a wine merchant that encourages investors to put their money into Bordeaux in the hope that it will increase in value enough to pay off their mortgage.
Good wine has performed well in recent years. The firm claims a managed fine portfolio would have outperformed the FTSE All Share by nearly 130% between January 1990 and January 2006. But it's also a risky, unregulated investment. Wine can add useful diversification to a portfolio but it would be rash to bet your house on it.
And now from wine to champagne, or at least a superficial reason to break out the bubbly. The latest news on the UK economy looked well worth toasting, with GDP growing by 0.8% in the second quarter, equivalent to an annual rate of more than 3%. These are first estimates and often change, but at first glance they suggest the UK is doing better than expected.
But dig deeper and a different story emerges. The growth has been largely fuelled by debt-fuelled spending from the public sector and the heroic British consumer. Private investment and exports remain worryingly weak. The latest Ernst & Young ITEM Club report points to the UK's trade with China as a striking example of our deficiencies. Although productivity in our manufacturing industry has improved faster than France and Germany's over the last decade, our exports to China are still lagging far behind.
Meanwhile, HSBC has crunched the numbers on Britain's recent growth record and worked out how much the public sector has contributed. The results are further vindication for those of us who suspect that much of the UK's supposed excellent performance in recent years is the result of the government's borrowing and spending spree.
Up until 1998, GDP growth and private sector growth remained roughly in line. But since then, the two have divulged dramatically. HSBC's numbers show that growth excluding the public sector was typically 0.5 to 1 percentage points less than the headline GDP figure. Last year, growth would have been under 1% without the public sector boost.
That suggests that once public sector spending slows, UK growth will be hit hard. To be fair, this is not necessarily a disaster: Ernst and Young reckons that the economy could still grow by 2.5% next year, as long as resources shift into exports and both consumers and the government tackle their enthusiasm for flashing the plastic.
There are ambiguous hints that individuals are starting to do this. Savings rates are rising, although some think this may be being distorted by increased pension provision by employers. Credit card borrowing is also coming down, although rising mortgage equity withdrawal raises the fear that consumers are simply dumping more debt on their houses.
But the government doesn't even get the benefit of the doubt. Public sector spending is supposed to slow in the very near future, with the Chancellor aiming for borrowing this year to be down on last year. But even that seems to be going wrong. Latest data show that public sector net borrowing is already running sharply ahead of last year.
You can't borrow for ever. The public may at last be recognising that. Let's hope Gordon Brown gets the message soon.
Turning to the wider markets...
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The FTSE 100 soared, up 114 points to 5,833. Gambling group PartyGaming was the main riser, up 7% to 104.5p as it continued to recover from concerns over a US crackdown on online gaming. Drugs giant AstraZeneca rose 4% to £33.14 on news that the US regulators have approved its asthma treatment a year earlier than expected. For a full market report, see: London market close (/file/15788/london-close-us-rally-inspires-charge.html)
Over in Europe, the Paris CAC-40 rose 96 points to 4,914 at close. The German DAX jumped 127 points to 5,578.
Across the Atlantic, the Dow Jones surged 180 points to 11,051. Merger fever gripped the market, as microchip maker Advanced Micro Devices bought Canadian rival ATI Technologies for $5.4bn. Meanwhile, solid results from drugs group Merck boosted sentiment. The S&P 500 rose 20 to 1,260, while the tech-heavy Nasdaq climbed 41 points to 2,061.
Asian stocks made gains on the back of Wall Street's positive showing. The Nikkei 225 climbed 210 points to 15,005. Games group Nintendo was a pominent riser after raising its earnings forecast for this year.
Oil was higher this morning, trading at $75.50 in New York. Brent spot was also up, trading around the $75 a barrel mark.
Spot gold was trading at around $619 an ounce this morning, after falling as far as $601.60 on Monday.
In the UK this morning, oil giant BP has beat profit forecasts for its second quarter, amid soaring oil prices. Replacement cost profit (regarded by analysts as the most accurate measure of oil company undelying performance) rose 23% to a record £3.3bn.
And our two recommended articles for today...
Forget funds it's picking markets that matters
- When it comes to maximising returns on your investment, it's not the fund you choose but the sector or geographical area you invest in that really matters, says Merryn Somerset-Webb. And there is a better, cheaper and simpler way to gain exposure to your favourite market or sector. To find out what it is, read: Forget funds it's picking markets that matters (/file/15784/forget-funds---why-its-picking-markets-that-matters.html).
How our sovereignty is still under threat from Europe
- The EU constitution may have been rejected by French and Dutch voters, but top politicians are hell bent on seeing it through by stealth if necessary. But what does it mean for Britain? Loss of control over everything from immigration to consumer protection, that's what. To find out just how great the threat to British sovereignty is and why it could prove the biggest challenge to Labour's chances of a fourth term see: How our sovereignty is still under threat from Europe (/file/15786/how-uk-sovereignty-is-still-under-threat-from-europe.html).
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Cris Sholto Heaton is an investment analyst and writer who has been contributing to MoneyWeek since 2006 and was managing editor of the magazine between 2016 and 2018. He is especially interested in international investing, believing many investors still focus too much on their home markets and that it pays to take advantage of all the opportunities the world offers. He often writes about Asian equities, international income and global asset allocation.
Cris began his career in financial services consultancy at PwC and Lane Clark & Peacock, before an abrupt change of direction into oil, gas and energy at Petroleum Economist and Platts and subsequently into investment research and writing. In addition to his articles for MoneyWeek, he also works with a number of asset managers, consultancies and financial information providers.
He holds the Chartered Financial Analyst designation and the Investment Management Certificate, as well as degrees in finance and mathematics. He has also studied acting, film-making and photography, and strongly suspects that an awareness of what makes a compelling story is just as important for understanding markets as any amount of qualifications.
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