Recently, the Governor of the Bank of England indicated that the UK faced the prospect of recession. He pointed out some of the factors that are slowing the UK economy down.

Falling House Prices. Falling house prices is an important barometer for state of economy. It affects consumer wealth and consumer confidence. IF house prices continue to fall, more will be pushed into negative equity which will reduce spending.

Rising Cost of Living. Rising food and energy prices is increasing the cost of living and making people less able to spend on other things.

Slow Down In Other Economies. Both the US and EU face lower growth. If our main trading partners slow down it will affect our exports.

Credit Crunch. Shortage of credit is making it more difficult to borrow, not just for mortgages but also firms wishing to invest.

How Will Recession Affect Housing Market?

• A recession in the UK, would lead to falling demand for houses. If unemployment rises then less people will wish to buy houses; there would also be a rise in home repossessions, which would reduce the demand for housing.
• Interest rates? Usually in a recession interest rates fall. But, the Bank of England are worried about rising inflation. They point to CPI reaching the governments target of 3%. Therefore, they are reluctant to cut rates. Therefore, if a recession is accompanied by inflation then it becomes more difficult to cut rates and makes the downturn more serious.

 Prospects of Recession in UK

A recent survey suggested that a majority of UK citizens actually welcomed falling house prices. Are falling house prices a good thing or should they be a cause for concern, requiring government intervention?

Reasons to Be Concerned about Falling Prices

1. Negative Wealth Effect. Falling house prices cause a decline in household wealth. This leads to lower consumer confidence and prevents people spending through equity withdrawal. The recent decline in prices have cause a big fall in confidence and led to significantly lower growth. Thus falling house prices can be a trigger that could precipitate a recession in the UK. This would create a negative downward spiral, with rising unemployment further contributing to falling demand for houses and falling demand for house prices.

• Housing is a big % of wealth and it is important barometer of economic well being; therefore the effect is likely to be significant.
• Some may say falling house prices will make first time buyers better off and therefore they can spend more. However, this group represents a small % of the economy. 78% of homes are already owned.

However, it is not guaranteed that falling house prices will cause a recession. For example, the recent devaluation in the pound will help boost exports. In America, they have sought to avoid a housing slump turning into  a wider economic slowdown through expansionary fiscal policy (tax cuts) and monetary policy (interest rate cuts)

2. The MPC have little Room for manoeuvre. Recent statistics show inflation is rising; this is due to rising cost push factors - energy and food. Therefore, because of rising inflation, the MPC will struggle to cut interest rates to boost the housing sector and economic growth.

3. Negative Equity. It is estimate that if house prices fall by 30%, 20% of mortgages could lead to negative equity. This presents a real headache for many recent home-buyers and will act as a disincentive for people to enter the housing market.

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Readers Comment: Additionally, there is also the average household income to mortgage cost ratio rather than against house price to consider. This is not nearly as dramatic as the ratio of income vs prices because mortgage costs are so much more affordable these days as interest rates are lower and the available mortgage terms are longer.

I agree. People look at house price to incomes ratios and say house prices need to fall 33-50%. But, when buying a house people don’t give that much importance to the house price to income ratio. The most pressing issue is - Can we afford the mortgage repayments? see: Interest payments as a % of income

The affordability of housing is very much different when average long term interest rates are 10% compared to current interest rate levels of 5%.

The main reason for the last housing crash in the UK was that interest rates were more than double current levels. This is what made mortgages unaffordable and caused a crash in demand; this led to 4 years of falling house prices or stagnant house prices. At the moment, the main problem is that the bank won’t lend people a mortgage.

If UK interest rates were to increase to 1990-92 levels, the housing market really would be in serious risk of collapsing; people like me couldn’t afford to maintain their variable mortgage payment. However, I think these interest rates are unlikely to occur. True, we are worried about cost push inflation - rising oil prices and rising food; but, these days we get excited when inflation rises to 3%. Inflation in double figures is a long way off.

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Readers Comment: Or, if lenders stop lending in the long term. In a normal world, as it becomes more and more difficult to buy, lenders will come up with more and more products to offset the difficulty of affording property. As that happens, prices will continue to climb. Making a mortgage term longer is a good example of a new product that can be extended to accommodate for the needs of an inflating property market.

To some extent I agree. There is no rule that house price / incomes ratios have to remain the same forever (as many believe). If a housing market has a shortage of new houses and rising number of households then house prices can increase above the long term average. One solution is getting longer term mortgages. I got a mortgage 6 times my salary because I didn’t want to rent for the rest of my life. One thing I did to make it affordable was to extend the mortgage term to 47 years (maximum possible). People will say it is irresponsible to get a mortgage 6 times your salary, but, it makes financial sense. The worst would be having to rent in Oxford when I retire. If rents continue to rise in line with inflation or higher, it would make retirement very uncomfortable. Getting a mortgage is a good investment for old age.

If long term house prices remain high people will look to getting different types of mortgages and longer mortgage terms are likely to become more common (Possibly with long term fixed rate mortgages)

Another thing that has happened is that first time buyers who can’t get on the property ladder have turned to their parents for help. e.g. borrowing money for a deposit. This is another way people have tried to circumnavigate the unaffordability of prices.

However, in the past few months the mortgage industry has been badly burnt with many mortgage deals being withdrawn due to the shortfall in available credit. In a way the problem stems from the US subprime fiasco, rather than a rapid rise in UK mortgage defaults. Nevertheless, mortgage products like 100% and interest only have fallen out of favour and in the current climate I can’t see them returning. However, longer mortgage terms are not risky unlike like 100% mortgages or interest only mortgages. They also offer mortgage lenders the opportunity to make more profit, because the total interest rate charged is much higher.

Related 

Extend Mortgage Term 

Increasing Mortgage term to 47 years 

Readers Comment: Prices will not drop significantly until employment starts to fall like it did in Japan and the UK in around 1990?

A rise in Unemployment would tend to cause downward pressure on house prices. People who are made unemployed are liable to struggle to pay their mortgage. Even the prospect of being made unemployed may be sufficient to deter people buying. However, house price drops don’t require large increases in unemployment. House prices in the US, are falling quite significantly, but, unemployment has remained relatively low in the US; there has been a small increase, but, the US unemployment rate is still around 4.5%.

In this case I think it more likely that falling house prices will cause rising unemployment. Falling house prices have a powerful impact on reducing consumer spending. Therefore, if house prices drop it will cause a slowdown in the economy, rising unemployment and this will only exacerbate the falling prices.

With house prices falling in the US and now UK, it is worth asking - who if anyone is to blame for the boom and bust in the Housing Market? This might help avoid a future boom and bust in the future.

1. Monetary Authorities.

In the US, we can point to how low interest rates were in the period 2002-2003. With interest rates less than 2%, mortgages became affordable to an increased number of income groups. The Fed appeared unconcerned about the housing boom and did nothing to prevent house prices rising rapidly. The same occured in the UK, the MPC only targetted CPI inflation. By stating there was nothing to worry about, the monetary authorities encouraged over confidence in the housing market and led to rising prices. If the Fed or MPC had taken action to take the steam out of the housing bubble, they would have avoided much of the boom and bust.

The Monetary authorities will defend themselves by arguing that the housing market doesn’t fall into their remit. ALan Greenspan claims there was nothing he could do to influence asset prices. [link] Their target is primarily low inflation and maintaining economic growth - not house prices. The Fed argued that in 2002, the US faced a real prospect of an economic downturn and they kept rates low to avoid this.

• However, the weakness of this argument is that the housing market has a very powerful influence on the economy. Because housing accounts for so much wealth in the economy, falling house prices are sufficient to tip the economy into recession. Therefore, Monetary authorities need to consider stability in the housing market as necessary precursor to a stable economy.

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Financial companies seek to make money out of us. By and large they are very successful. The profit of the top banks is second only to the oil companies. This means we need to be wary of their attitude; we need to bear in mind, that to save ourselves money we will have to see through their sales technique, small print and things they would rather we didn’t know. If we an attitude of deference and loyalty to the big finance companies, they will just sell you their most profitable products, making sure you receive the lowest return on your financial situation. These are some tips to get a better deal from the financial system.
Using A Credit Card / Interest Free Overdraft as a Loan.

It is possible to use a credit card as a means to borrow money at very low rates. It requires some care; but, if you build up a balance and then transfer it to other cards, it is usually possible to enjoy interest free credit for upto 12 months. Typically, banks now charge a 2% balance transfer fee. If you switch credit for 12 months, it is an effective interest rate of 2%. Much better than loans or the usual interest rate on credit cards. However.

• Make sure you stick to the agreement and never miss a payment; they will use this as an excuse to cancel the 0% agreement.
• Don’t get overconfident and borrow thousands of pounds assuming you can switch it all to 0%, if you become too indebted banks may stop giving out 0% interest credit cards.

Always Protect Credit Rating.

If you have a good credit rating, these tips become much easier to do. If you develop a bad credit rating, you will find it more difficult and expensive to take out financial products. This is especially true in the current climate. Protecting your credit rating is so important it should be taught in schools. But alas, it isn’t. However, you can teach yourself - most of it boils down to common sense. See Tips for improving credit rating

Complain

Banks know the importance of Public Relations. They don’t like unhappy customers. If you have receive a late payment penalty, or charged for going £1 overdrawn, don’t just feel miserable and inwardly curse the bank. Write a polite letter explaining why the penalty was unfair / not deserved / an accident due to lost post e.t.c. You may be surprised that banks often respond to complaints in a favourable way. If they don’t respond suggest the local newspaper may be interested in the story of an 70 year old lady charged £60 for going £0.05 overdrawn. Remember there are many things that you can complain about, such as failure to explain alternatives or failure to explain all terms and conditions. For example, many British customers gained a refund from taking out personal loan insurance. Banks were found guilty of misselling, many millions of pounds still remains unclaimed.

Complaining to Your Bank 

Don’t Stay With Existing Products For Ever.

This is the biggest single mistake people make. Financial companies view these loyal consumers as the ‘cash cows’ - basically they are easy pickings. Even if they get charged high interest rates, the banks know they will not lose these customers because the customers are either too lazy to switch accounts or have a mistaken feeling of loyalty to the company. It is the same for insurance, savings accounts and mortgages. Sometimes it is just a matter of asking the bank for a better deal or renegotiating your insurance deal. Some customers are amazed that if they ask for a new quote, it maybe their existing company who offer
the cheapest deal.

• Every year take the time to renew your big bills and outgoings; true it takes time but the hourly savings make it very worthwhile.

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Jim O’Neill, chief economist at Goldman Sachs who correctly predicted the fall in US house prices has warned that the UK economy will be hard hit by the global credit crunch.

He warns that UK mortgage markets appear effectively frozen, even the Bank of England’s attempt to inject liquidity into the market doesn’t seem to be working. With mortgage lending halted, house prices look set to fall, creating a period of negative equity and falling consumer confidence. For an economy that has relied on consumer spending, this will be a significant problem.

Furthermore, the strength of the UK economy, is also based, to some extent, on its financial services sector. The credit crunch is liable to lead job losses in this sector and this will reduce spending amongst an influential sector of consumers.

• Credit Crunch Explained 

The housing market is facing acute short term difficulties. In particular:

• Drop of mortgage lending (there has been 45% fall since this time last year) has caused a big fall in demand for housing. It means that potential homeowners, especially first time buyers are finding it very difficult to get a mortgage. If this freezing of the mortgage market continues, house prices are liable to fall quite significantly.
• A good question is how long will the mortgage crisis last? The Bank of England has attempted to inject liquidity by offering £50bn of government securities; they even promise up to £100bn. However, there are signs that this is not creating extra finance as hoped. Most banks have still not passed on the lower rates. There are also fears that the full extent of the subprime losses have not been accounted for. Therefore, some feel the situation will get worse before it gets better. Nevertheless, over time, lending in the mortgage markets is likely to improve (even if it doesn’t get back to 2006-07 standards). It is in the banks interest to resolve the shortage of mortgage funding. There is demand for mortgages and they should be profitable for banks if they can sort out the issue of raising finance.

Long Term Interest rates.

As house prices slow, the economy will also slow. This should enable cuts in interest rates. This is complicated by a rise in cost push inflation. However, these cost push factors (such as rising oil, food and energy prices) are liable to be short term. It is unlikely that commodities such as food will continue to rise at their present rate. Oil prices may remain high over $100 a barrel, but to maintain the present annual increase in prices, would be very unlikely. In the medium term it is unlikely that we will see a significant rise in interest rates; it is more likely that interest rates will be slightly lower than the current 5% rate. Therefore, borrowing for a mortgage will remain relatively attractive compared to renting. The long term affordability of mortgage payments is below historical peaks in 1991. As a % of disposable income it is not unreasonable to predict that demand for mortgages will remain strong amongst the UK population.

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A good credit rating is vital to being able to access loans and mortgages. The importance of a good credit rating is even more important now that the credit crunch has made lenders suspicious of people with bad credit histories. These are some tips on improving your Credit Rating

1. Check Your Credit Rating.

It is important to know your current credit rating and check to see it is accurate. You can have access to your credit rating through an agency like Equifax and Experian Under the consumer credit act of 1974, you have a right to see it at a cost of £2. This £2 figure is determined by the government, so if agencies start charging a lot more be very suspicious. If you see any discrepancies chase them up with the financial insitution involved.

2. Understand why you were turned down.

Although it is not compulsory, most firms will explain why they turned you down. This can be useful for understanding what you need to do. It can also help you avoid applying for the same products and getting rejected in the future.

3. Avoid Getting Repeatedly Rejected.

If you have a trail of turned down applications, other companies will start to be suspicious. If you get turned down, try to understand why, wait a while and then try again. Avoid applying on mass; make sure you do one at a time.

4. Good Budgeting.

The best way to avoid a bad credit rating. Is to spend time on organising your finances. Make sure you know how much you can borrow on your bank overdraft. Be prepared for occassions when you get close to the limit and take preemptive action. Most problems and bad credit ratings occur because of poor planning and lack of awareness of the financial situation. It is worth spending a little time to organise your finances and avoid unnecessary missed payments.

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