Rising mortgage rates have dominated much of the news and economic debate for the past few weeks. Gus Williams, the Chief Executive Officer at Bevan Buckland LLP, takes a closer look below.
Ignoring rental properties, there are around 16 million households in the UK. Approximately 9 million of these are owned outright, and about 7 million have mortgages. Approximately 3.5 million of these will have remortgaged since the Bank of England started raising rates. Hence, approximately 3.5 million households have yet to remortgage and will likely find that their monthly payments have increased significantly when they do. Add in the 10 million or so households that rent, and we get to a figure of around 13.5% of households who are exposed to current rate rises in the short term.
It is of little comfort if you are in that 13.5% of households who will need to remortgage in the next 12 months, but 86.5% of households are not exposed to current mortgage rate rises, so the first thing to note is that while not great for the economy, mortgage rate rises do not pose an immediate existential threat to the economy on their own. Energy prices rising again, which impact all households and businesses, would, for example, be a much greater concern.
What is more important to the economy is how rising mortgage rates will impact the housing market generally, given that the housing market and house prices, in particular, can significantly affect overall economic activity and the economic feel-good factor.
House price crashes have been widely predicted for the last 30 years but have never really materialised.
Houses are priced at the margin; that is to say, there are an average of 60,000 house purchases each month in the UK, against a total stock of 26 million, so only 0.2% of houses are priced in any given month. This is just another way of saying that houses are worth what the next person is willing to pay, not necessarily based on any intrinsic value.
This marginal pricing means that supply versus demand changes can exaggerate house pricing.
Generally speaking, as we have had for most of the past 30 years, demand has outstripped supply and prices have remained strong. House price crashes often go hand in hand with repossessions. Repossessions cause supply to increase at a time when falling prices persuade buyers to wait it out. The first fear from rising mortgage rates is, that repossessions will increase and tip supply and demand. Banks have learned that repossessions are bad for business; they cause a house price spiral that crystalises their losses. Bank regulations on mortgage affordability have relaxed in the sense that banks can now extend loan terms up to 40 years in some instances. The regulators and government have also shown a willingness to allow mortgage borrowers to switch to interest-only loans.
I guess that this time, banks will only use repossession as a last resort; therefore, while repossessions will rise, they will not rise to the same level they did in the 1990s.
Repossessions peaked at 78,000 in 1991, and they are currently somewhere around 7000 per year.
Also supporting the likelihood of fewer repossessions now versus the 1990s is that most homeowners now have a lot more equity in their homes after many years of price rises.
Positive equity makes homeowners more likely to do everything to keep hold of their homes.
Affordability thus becomes the bigger question about where house prices will head.
Most people judge affordability by the monthly mortgage payments they have to make, but before we get to that, there is one other factor we need to look at which has been driving house price rises: the Bank of Mum and Dad. Somewhere between 40-50% of all first-time buyers rely on help from their parents for a deposit. Therefore, the Bank of Mum and Dad has significantly propped up the market. The cost of living crisis may put a strain on these flows. However, wealthier parents are likely helping out their children, and the cost of living crisis may not be impacting them as hard, especially as the older generation is more likely to have inflation-protected pensions.
Affordability, though, has to be a zero-sum game. People can only pay what they can pay in terms of their mortgage, and increased mortgage rates mean they can borrow less. Twenty years of low rates have been the main driver of house price increases, so a return to a more normal long-term trend of rates around 3-4% will undoubtedly mean that house prices will need to re-adjust. The question is whether there will be a sudden reversion to the mean or a more gradual adjustment.
In favour of a more gradual adjustment is the fact that rental costs are rising even faster than mortgages, so while mortgage affordability may be getting worse, the cost of the alternative is not any cheaper. This may provide some support to house prices moving gradually.
For house prices to crash, we probably need to see unemployment rise, causing people to be unable to pay their mortgages and move back in with their parents.
That said, all house prices are not equal. In Wales, most valuations have not reached the excesses of elsewhere in the UK. We are more likely to see greater regional variation in house price movements. Demographics mean the population is ageing and family sizes are shrinking. We could see house prices being driven by changes in the demand for different types of houses. The supply of large houses in rural and semi-rural locations could rise as older people look to downsize, while demand could fall as fewer people have large families. On the flip side, demand and prices for two-bedroom bungalows in popular retirement areas could outstrip supply and keep prices relatively high.
Anecdotal evidence is that the last month has caused havoc in the housing market as deals fell through as mortgage deals were withdrawn, but the chances of an immediate crash look low based on the underlying factors. However, it only takes a slight shift in the market supply and demand dynamics for things to change quickly. The number of house purchase transactions will likely come down, but the supply and demand balance in Wales may be maintained for now, especially for homes of the type and in the areas where demand remains strongest. Rising unemployment is more likely to be the future trigger for house price upheaval than the current mortgage rate turmoil, so that is the figure to watch out for.
As a footnote, there will be some winners who benefit from the current inflation and interest rate rises.
If you are fixed for ten years below 2% and are in secure employment where your wages keep pace with inflation, then you will see the value of your debt and mortgage repayments fall relative to earnings under the principle of debt erosion. Those who bought in the 70s and 80s did very well out of this principle.