Defaults in UK and US Mortgage Industry

Is the UK mortgage industry likely to experience same problems of debt default as US mortgage industry?

Defaults on American mortgages have been making headline news recently with a record number of defaults; up to 4.95%. For the sub prime market this rate of defaults has reached 13%. Some are concerned that there are similarities between the American housing market and the UK housing market and in the future the UK could experience a similar level of defaults. However it is worth pointing out that there are differences between US mortgage industry and UK.

1. The number of 100% mortgages is much lower in the UK. 100% mortgages are quite rare, especially in the bad credit or sub prime sector. In the US 50% of sub prime mortgages were 100% mortgages

2. UK mortgage dealers are generally more risk averse. Even for self-cert mortgages there is more checking of income than in the US. See dangers of sub prime mortgages.

3. House prices are not falling. In the US many now have negative equity with no possibility of Remortgaging. Some believe the UK housing market is overvalued, however it is worth remembering that supply constraints in UK the may enable house prices to keep rising. see house prices to keep rising

4. Interest rates in the US have shot up sharply. US interest rates have increased from 1% to 5.25%; this is the main reason for loan defaults in the US. Interest rates have risen by more than people expected. In the UK interest rates move much more gradually. E.g. in the last 8 months there has been 3 increases of 0.25%

5. In the UK fixed rate mortgages are more common than in the US. These give additional security against rising interest rates.


However it is worth bearing in mind that

1. UK house prices could fall. The house price to earnings ratio is at an all time high and it has made it difficult for first time owners to buy. House prices could fall

2. UK consumers have a high % of indebtedness. This makes them susceptible to any future rise in interest rates.

3. The sub prime market in the UK is likely to grow. Figures by Datamonitor show 9.1 million people of working age were refused credit by mainstream lenders during 2005. In 2010 this figure is predicted to rise to 9.4 million.


Reference

Independent

Dangers of Sub Prime mortgages

In the past week headlines about the US mortgage industry have dominated the news. In particular the number of defaults on mortgage payments is growing very rapidly. These defaults are concentrated on the sub prime sector. These mortgages are aimed at those with bad credit or non-status. Often these mortgages are approved without making any checks about the income status of the borrower. In the UK there has been a similar increase in the number of self-certification mortgages and other non-conventional mortgages.

The growth in sub prime mortgages has been very significant. In the US it has allowed over 6 million people to be able to buy a house for the first time. However the success of the sub prime market was mostly dependent on rising house prices. Rising house prices enabled borrowers to remortgage (refinance); this means that after a couple of years they were able to switch their mortgage and get a better deal. Rising house prices were particularly important for people who were getting 100% mortgages. This is a mortgage with no deposit. Because of the risk traditionally these 100% mortgages lead to higher interest payments. However if house prices rise it means the mortgage becomes a smaller % of the value of the house.

Unfortunately the situation is that US house prices are now falling. This means that homeowners are unable to remortgage and in many cases are left with negative equity. (house worth less than the mortgage debt)

Dangers of “Teaser” Mortgage Terms.

Another feature of sub prime mortgages is that often there was a special introductory rate to make mortgages more attractive. For example in the first year or two the interest rate on the mortgage was much lower than subsequently, this had the effect of encouraging borrowers to take on a mortgage that becomes increasingly difficult to pay back. Therefore as more sub prime mortgages reach the end of their introductory period the number of defaults is likely to grow.

The Guardian (16^th March 2007) report the story of Simeon Ferguson an 85 year old father with dementia. Unwittingly he took on a new mortgage with a fixed rate for 30 years. The introductory teaser rate offered him a monthly payment of $1,482, however after 3 years this jumps to $4,200. It is only at this point that the mortgage involves capital repayment. However the pension of Simeon Ferguson is only $1,100 a month. This is an extreme example of how US mortgage companies have been willing to ignore the most basic of credit checks in order to be able to sell as many mortgages as possible.

from Guardian

• See also More defaults on US mortgages
• Non Status Mortgages
• Shakedown - sub prime jitters in US at Economist
  

Will Mortgage defaults cause a recession in the US?

Will an increase in Mortgage defaults cause a recession in the US and rest of the World?

At first glance it seems a relatively small problem. Within the US sub prime mortgage markets there has been an increase in defaults to 4.95%. The sub prime mortgage is a growing but still relatively small section of the US housing market. Nevertheless there are worries that this small incident could cause a negative multiplier effect and could push the US economy into recession. Furthermore although the US economy is not as dominant as it used to be. There are still legitimate fears that a US slowdown could spread throughout the world economy.

Why Mortgage Defaults and Problems in the US Housing Market can cause a Recession

1. Bad Debts for Banks. Mortgage defaults are costing banks and lending institutions significant sums in debt they have to write off. For example HSBC recently had to write of $10.5bn in bad debts from the US sub prime mortgage industry. This contributed to a fall in HSBC share price. Also leading financial institutions are re-evaluating their attitude to risk. Now defaults are growing and house prices are falling they are much more reluctant to lend to what they consider risky investments. The effect of this is to reduce investment levels and therefore reduce the rate of economic growth.
   
   
2. Loss of Confidence. The impact of consumer confidence on the economy should never be underestimated. In recent years the US economy has been buoyed by consumer spending, often financed by high levels of borrowing and rising house prices. As house prices fall and bad economic news makes the headlines; consumers will reduce spending, borrowing and increase savings. This will lead to lower AD and therefore could cause lower economic growth.
   
   
3. Negative Multiplier Effect. The multiplier effect relates to how a problem in one economy can spread throughout the rest of the economy making the initial problem worse. For example the sub prime mortgage may only affect a small % of the population, but if those facing higher debt payments reduce their spending it effects other shopkeepers and firms. Therefore with less income coming in they may reduce their employment levels causing a further fall in AD and this negative spiral can increase (especially when confidence is low)
   
   
4. World Recession. The US economy has been a major factor in determining economic growth in other countries. For example the US has been buying a high % of Chinese exports. If the US economy were to go into recession many countries would experience a fall in exports and therefore fall in economic growth as well. This could be exacerbated if there is a continued fall in world stock markets. However it is worth noting that the US economy is a smaller % of the world economy than it used to be. There is a growing Chinese and Indian middle class who make take up the slack in global demand.

See also:

• Is US heading into Recession?
• More defaults on Sub Prime Mortgages in US