Well, the latest news is that Nick Clegg – our deputy PM – has come up with a scheme for parents and grandparents to guarantee the deposits for their children to buy a home.
This could be a really bad idea for so many reasons.
I’m going to leave aside the obvious – that this excludes everyone without a nice big lump sum stacked up in their pension fund (a whole different – moral – issue) and just address this for the housing market impacts.
I’m also only going to touch on the suspicion that accountants and lawyers will already be working on complex, “tax-efficient” schemes to let the 1% save for their little darlings pied-a-terre using their (tax relieved) pension schemes. I’d guess these may supplement the 12,500 who the Beeb report says could “potentially benefit”.
(Oh, OK then, here’s an idea how that would work – pay £60k into AVC’s, claim back the 40% tax to gross up the fund to £100k and secure as a deposit).
The Problem …
For decades, UK families have pumped any increase in disposable income into buying a new home. This has inflated housing prices (sustaining the problem), and means that people are working harder just to stand still.
Recent globalisation changes, however, mean that middle class incomes have been squeezed, and that there’s little real prospect of income (or – as a result – house price) growth in the foreseeable future. And price inflation is still positive, so we expect a fall in disposable income.
And a number of sources seem to support the idea that the UK housing market is overvalued. The IMF estimates that this could be by up to 30% !
So why aren’t prices falling ? Well, interest rates are ridiculously low, partly as a result of quantitative easing. The liquidity intended to boost the economy is keeping this – admittedly important – sector of the economy afloat.
Foreclosure and repossession – as we learned shortly after 1990 – means properties sold at distress values, which drives the market down. So – while the interest cost isn’t causing pain, the banks will be content to not kick off another round of negative headlines by evicting large numbers of their customers.
Of course, that may change if they have to start declaring losses …
“Doing the Math”
House prices move to reflect the disposable income available to meet mortgage payments (I’m ignoring the effect of the private rented sector, here, for simplicity).
So if I have £800/month available, and interest rates are 4%pa, then I can afford a mortgage of £800*12/.04 = £240k.
If interest rates go up to 6%pa, however, those repayments will go up to £1,200/month – and I’ll have to find another £400 at a time when salary levels are static.
And in this case, a household with the same disposable income of £800 will only be able to afford a mortgage of £160,000 (£800*12/.06).
So there would be a lot less people able to buy my house (it takes more than one buyer to create market competition), and prices will fall – as people either need to move, or as banks eventually start repossessing. The move to fixed rate mortgages – not such a component in the 90’s crash – may spread this over time, but supply-and-demand means that prices will fall (especially in a thin market).
Interest rate increases may still be a year or two away, but they will come. And they’ll come as a shock to those who’ve made long-term decisions.
For those who weren’t around at the time, take a look at the Nationwide graph of the House Price Crash. 1986-1990 saw the “real” price increase by 56% – from £88k to £129k. Then interest rates went up. A lot.
And repossessions started.
By 1992 prices had dropped all the way back to £81k.
Of course, they’ve been trending down again since 2007, but when the banks think we’ve hit the bottom of the market, then deposit percentages will come down.
Trying to get a mortgage …
… has become difficult for first-time buyers, as the banks are asking for 20% deposits – over £30k for an average property, more in London. The narrative tends to be that the banks are being overly cautious, but, in reality, they’re probably being not unreasonable in reflecting the increased medium-term risk in the overstated market.
Buy to Let …
… on the other hand, is doing very nicely. If you already have properties, then you can buy more (being selective, at the right price) by leveraging the (over-valued) equity in your existing portfolio.
Interest rates are low, and – as more and more people need to rent – residential rental rates are going up.
There’s still that capital risk down the line, however…
Pester Power ….
You’ll be using your pension, ffs, to guarantee a house price in an overvalued market. So if/when prices do get more realistic, then that Round-the World trip you’d got planned for your lump-sum payout ain’t going to happen. Even if prices don’t fall, the mortgage is still likely to be running …
Then there’s all the acrimony with your children, when they can’t afford the repayments any more, and can only sell at a price that covers the mortgage.
Even for those with reservations about this scheme, it can be difficult to say “No” to those you love. But this scheme could mean “Pester Power” endures until your beloved offspring are in well into their 30’s.
I’m a Homeowner …
… and I’m in favour of people buying their own homes. Although I like the idea I’ve an asset, my home is somewhere to live.
I dont have children, or a lump sum to claim, so I don’t really have a direct interest.
But – as with any market – you should buy when prices are low and sell when they’re high.
Remember house prices don’t always go up.
Remember that early in life, you’re likely to move more often – crystallising any losses.
Remember and that buying / selling property costs money (stamp duty, estate agents, solicitors just to start with).
History suggests that using schemes like this to distort the market in the medium term have historically been liable to end in tears.
Like the 120% mortgages once offered by Northern Rock – which could never be covered by the sale of the house in a “flat” market.
And I include the government’s “NewBuy” scheme in these distortions. This offers a 95% mortgage to people buying newbuild properties. But, of course, once you move in, it’s not a newbuild anymore.
So if you need to sell, then your buyer can only get an 80% mortgage. Alternatively, they can still get a 95% mortgage on a “real” newbuild. Probably even for an identical house on the same estate. The payments may be higher, but the deposit isn’t the constraint.
And that’s without recovering the premium charged for newbuilds – together with the carpets, kitchens etc. that often go with the deal.
So this may be good for the construction industry, but it’s not necessarily a good idea for their customers.
The UK housing market over the last 30 years is littered with examples of housing equity wealth being stripped – from endowment mis-selling to HIPS. Now, with all the equity stripped out of housing, a new scheme turns up to pump more money into this mostly non-productive sector – by stripping out pension provisions (which are, apparently, already inadequate).
This may be suitable for some, but if you go for this scheme, make sure your eyes are open.
I’m not a financial adviser, and you shouldn’t make personal financial decisions based on this article. Seek independent qualified advice before making important financial or life decisions.
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