The shock rise in inflation this month to its highest level for 15 years, prompting Mervyn King to write to the Chancellor, made a further hike in interest rates on 10 May an odds-on certainty. Worse still, there seems to be a growing expectation that rates will continue to rise and could reach 6 per cent by Summer.
These successive rises, from a low of 3.50 per cent in Summer/Autumn 2003, could leave rates a massive 70 per cent higher than they were 3.5 years ago. While in historical terms 6 per cent is not a high rate, the percentage rise in the monthly mortgage payment for a variable rate borrower is substantial.
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The other factor is that lenders have been offering higher income multiples, on the basis that low rates make them affordable. Progressively, income multiples have increased – just weeks ago the Daily Telegraph reported that some lenders will now lend six times income.
Well rehearsed
The arguments why these steadily higher income multiples are not unduly risky have been well rehearsed. Mortgage rates, as we know, are much lower than they were in the late 80s and early 90s, even after the successive rises in recent years. Borrowers’ average mortgage payments as a percentage of monthly income have risen from less than 11 per cent in 1996 to around 18 per cent now, but remain well below the peaks of over 28 per cent in 1990.
The other difference in 2007 as compared with 1990 is that today’s borrowers have much greater opportunity to protect themselves by opting for fixed rate loans. This gives them certainty over their mortgage payments for a while, and enables them to budget for the early months when they are financially stretched.
Nonetheless, fixed rate borrowers remain exposed to a ‘payment shock’ when their fix comes to an end and they either move onto variable rate or remortgage at an inevitably higher fixed rate – if it is available.
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Indeed, since the latest interest rate rise we’ve seen the withdrawal of a number of fixed rate deals, and other lenders have pushed up the cost of their fixed rates as swap rates have risen. This will have an impact on existing borrowers and first-time buyers who could end up paying a lot more. People coming off a two-year fix today and being switched onto standard variable rate will be paying over 2 per cent more, for example.
Stretching safe boundaries
It seems clear that with rates likely to rise again, further extension of lending multiples could start to stretch the boundaries of what is safe and prudent for lenders and borrowers. I accept that the mortgage industry has come a long way in terms of the sophistication of its underwriting procedures and its ability to price for risk, but the fact remains that many of today’s lenders have no experience of a recession.
Indeed, the progressive easing of lending criteria gives me an uneasy sense of déjà vu. If we look back a couple of decades, we can see how uncontrolled expansion in the amounts lenders were prepared to lend and the amounts consumers were willing to borrow, combined with a significant downturn in the global economic environment, led to the most severe property recession in a generation. It would indeed be a pity if we did not learn from our mistakes.
Now the regulator has sounded a note of caution, warning that while the UK and US mortgage markets are fundamentally different, there are parallels and some UK borrowers may be taking on dangerously high amounts of secured debt. Lenders, for their part, are taking on substantial risks through a combination of high loan-to-value and high income ratios.
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Fortunately, there is some evidence that the market is starting to cool, which should start to impact on the growth in mortgage debt. The latest Halifax and Nationwide data would suggest that house price inflation is beginning to stabilise, although Rightmove’s latest asking price figure did show an unexpected blip in April.
Rising rates are undoubtedly playing their part in tempering borrowers’ appetite for ever higher levels of mortgage debt. It has also been suggested in some quarters that the introduction of Home Information Packs (HIPs) in June may depress property transaction levels, at least temporarily.
In short, many of the contributory factors of the 1990s property crash do not appear to be present this time round: sky high interest rates; a collapse in global economic confidence; a sharp increase in unemployment. But we should never say never, and perhaps now is a good time to ease back on the accelerator and let the market return to an equilibrium. That might even spare us some of the future interest rate pain.
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