An email comes from a reader. She has read an unusually rude criticism of MoneyWeek’s bearish stance on house prices and wants us to answer a few questions.
First, she asks why traditional income ratios matter when interest rates are so low. After all, if she can get a mortgage at 2.39%, as she says she can, what difference does it make if she borrows four times her income?
She has a point – but not a lasting one. Why? Because interest rates won’t stay low forever. If you borrow money today, you need to be sure that you can meet your monthly payments, not just at 2.39%, but at 5%, at 7% and perhaps at 10%.
We don’t see rates going up immediately, partly because we expect the global deflationary scare to run a bit longer, and partly because Mervyn King has made it very clear that he will support the new government as much as he can by keeping rates low as they slash spending. But the Bank of England can’t ignore its targets for ever. That means rates will have to go up in the end – and then our reader’s monthly mortgage payments will, too.
But it doesn’t have to be interest rate rises that force the next fall in prices. Low interest rates have allowed the financially stressed to hang on to their homes. But the cuts in public spending, along with the trauma in most of our export markets, suggest that unemployment might soon see another rise. Can the over-leveraged hang on to their homes even when unemployed? We’ll see.
And rising unemployment isn’t the only thing likely to push up supply in the market. Consider the rise in capital gains tax (CGT) to the same levels as incomes. That means whopping great bills for second-home owners. A house bought for £100,000 in 1985 would now be worth £490,617, says the Nationwide. Sell it today and you’ll pay CGT of £68,500. Sell it when the rate goes up to 40% and, assuming no allowances are made for inflation, you’ll pay £152,200.
That suggests that you should get out now. Indeed, if you own a second home it also gives you a huge incentive to sell at below what would have been the market price. Sell the £490,617 house now for £450,000 and you’ll still pay less tax than if you waited and sold after the tax rise.
But the tax rise also makes a big difference to the buy-to-let industry. Much of the benefit to being in buy-to-let has come not from net yields (which have all too often been negative) but from capital gains. Paying 40% on those capital gains, such as they might be, can only make the business less attractive. That will push up short-term supply in the market and push down long-term demand.
On the demand side, I’d also point to the fact that mortgages are still not that easy to come by. Mortgage approvals for house purchases came in at 48,901 in March. The long-run average is well over 90,000. At the same time, mortgage lenders are already warning about a looming £400bn funding gap as the Bank of England withdraws special support schemes introduced at the peak of the financial crisis.
Our reader also makes the point that inflation should be great for those with whopping great mortgages. It means that the price of your house goes up and the real value of your debt goes down. I addressed this last week so I’ll just let you read here why this isn’t necessarily so.
Finally she suggests that the housing market won’t fall because the government just won’t let it. The Bank of England won’t raise rates enough to crash the housing market because “that would be madness.” And anyway a crash would mean another recession which would mean falling tax revenues and make our national debt even harder to service. “So the UK has to have rising house prices to keep paying the country’s debts – and the government will make sure it happens.”
This is touching stuff. So far, if there has been one big lesson from the financial crisis it has been this: no government can make sure of anything. The US couldn’t stop the subprime crisis; Gordon Brown couldn’t stop boom and bust; the Monetary Policy Committee can’t stop inflation consistently rising above target; Greece can’t make its people accept austerity; the Irish government couldn’t stop house prices falling by 40% plus; Spain can’t stop unemployment rising above 20%; and Germany can’t stop the market slaying the euro.
So why on earth would anyone think that the UK government – even the new one – would be able to stop house prices falling?
None of this suggests our reader shouldn’t buy her dream house if she finds it and can easily afford it (even with rates at say 10%). Just that if she does, she should be prepared to find that doing so doesn’t exactly make her fortune.