Is the Housing Panic Justified?

As the saying goes - There are lies, damned lies and statistics.

It seems that there are no end of statistics about the housing market, some of which can seem a bit contradictory.

At the moment there is a general assumption that UK House prices are set to fall and are vastly overpriced. However, before you rush out to sell your house, there are a few things worth bearing in mind.

1. House prices are not significantly above long term average compared to earning.

Graph of House Price Affordability 

• I should point out that this graph finishes in 2005, and since 2005 house prices have increased considerably. Therefore the ratio of house affordability is higher than this graph shows.
• If you had chosen 1995 as the starting point of the graph, of course, things would look a lot different, (in 1995 the affordability of housing was at an all time low) Even since 2003, there has been a considerable increase in the ratio of house prices to earnings. (See ratio of mortgage costs to earnings for first time buyers)
• However, compared to the peak in 1990 house price affordability is not that bad.

Why are House Prices Still Affordable despite House prices doubling in the past 5 years.

There are two factors which determine the cost of buying a house.

1. The actual house price
2. Interest rates, which will determine the monthly repayments.

If house prices go up, you have to take out a bigger mortgage, but if interest rates fall it is relatively cheaper to borrow the money. In 1990 interest rates reached 15%, now in 2008 they are 5.5% and likely to fall to 4%. Thus, there is not the same worry about mortgage payments becoming unaffordable that there was before the last house price crash

If you look at this previous post on the Interest rate cycle, you can see how UK interest rates are considerably lower now than at any other period in the past 3 decades. It is this fall in interest rates which have kept the affordability of housing reasonable, despite the rapid increase in prices.

The main factor behind low interest rates is the low inflation rates.

If ever interest rates in the UK rise to 8-9%, then we should really start to panic. Many homeowners would be unable to pay back their mortgage payments and repossessions would rise. - This is when there really would be a housing crash. But with inflationary pressures relatively subdued and the threat of recession increasing, higher interest rates are unlikely, at least in the short term.

Anyone want to bet on rising house prices ?