Mortgages Uncovered

There is now an estimated 10K buy to let landlords that are more than 3 months behind paying their mortgage, in accordance to research from the independent financial advisers, Hargreaves Lansdown. There is strong likelihood that more will follow as they start struggling to meet repayments as many more landlords are starting to come off or are due to come off their cheap 2 and 3 year fixed rate mortgage deals during 2009 and 2010.

In the past few years, there was a sudden boom in buy to let, with property investors starting to make up a large proportion of the market’s property buyers. At the time they were able to take advantage of cheaper mortgage deals from lenders during 2006 and 2007.

However, since the onset of the credit crunch, current mortgage rates (particularly on buy to let deals) have been steadily rising. In addition, there are many landlords who have, in recent years, just bought properties and may now be in negative equity due to average house prices slipping by 10% since their peak in the summer of 2007 and are widely predicted to fall again over the forthcoming months. Landlords could now be left with a (or several) depreciating assets in future with higher repayments on the loan used in the first place to buy what was supposed to be an asset.

A pension’s analyst at Hargreaves Lansdown suggested that borrowing to invest was now a hazardous strategy. His assertion, however, about the merits of saving in a pension scheme does come with caveats. But, just like their ‘property investing’ counterparts even pension savers have not fared well during the past 12 months, as UK share prices tumble even further than house prices.

Alistair Darling is now poised to intervene in helping banks to secure more finance in order to grant new mortgages. This likely move comes right after the virtual drying up in 2007 of the mortgage backed securities market, which was a crucial source of mortgage lending.

Recent figures indicated house prices were continuing to fall, with home buying activity sinking to its lowest levels for 40 years.

The Chancellor will order an extension of the Bank of England’s £50 billion emergency special liquidity scheme which was introduced this year to help ease intense funding strains on the banks which was triggered by the credit crisis.

The scheme now allows banks to swap their mortgage backed bonds issued before the end of 2007 for trade worthy Treasury bills that can then be further used to raise additional funds in the markets.
An extension of the scheme opens the way for the acceptance of new issues of mortgage backed securities which were made since December 2007 in another attempt to boost financing available to banks for new home loans.

Mr Darling is to also consider a more controversial multibillion plan for the Government itself to guarantee temporarily high quality mortgage backed securities. This may then help to create investor demand for government-backed bonds which will assist lenders to sell their loans and increase the supply of finance for lending.

Both proposals may run into significant resistance from Bank of England. Officials are thought to see not much of a case for accepting the new mortgage loans into its’ emergency financing scheme, due to lenders having large stocks of already eligible bonds that they have yet to swap for Treasury bills. The Bank of England is likely to be very wary of a publicly funded subsidy for new lending option.
The Chancellor is of course, also still considering suspending stamp duty temporarily as a further way of boosting the market.

There was further evidence of cheaper deals for mortgages emerging last week following a recent move by Northern Rock.

Woolwich, who are part of Barclays, pushed their 2 year fixed rate deals, popular with first time buyers, below 6%, whilst a division of the Yorkshire Building Society just announced a fresh range of products obtainable only through mortgage brokers.

As lenders started to compete in the moribund market, there was further discussion about the extent of the competition posed by the state owned Northern Rock.

An industry source stated that there were raised eyebrows regarding the competition from the publicly funded lender and further surprise at the launch of aggressively priced products.

Northern Rock offers a 2 year fixed rate of 5.89% for customers with a deposit of a minimum of 25% of their property’s value. Bank of England data now shows that the average rate of such deals was at 6.36% in June. This new product offered by Woolwich is 5.99% and available to customers with deposits worth 60% or more of the value of the property.

Northern Rock has re-priced its range 4 times recently and pledged not to take a higher percentage than 2.5 of the market in any calendar year. Its share in the first half of the year was 1.2%. The new product range, also includes 10 and 15 year deals and is aimed at new customers it’s not available to existing customers whom it is now encouraging to leave them as part of its strategy to repay the outstanding £17.5 billion of taxpayer loans.

The high deposits now demanded confirm the trend reported by the CML which calculates that the average homebuyer puts down an average 22% deposit in June, up from 20% in May. Most lending now continues to be on very conservative terms, lending criteria has tightened in response to the shortage of funding in current market conditions.

However, fluctuations of rates in money markets do make it easier for lenders to cut their rates, despite the higher than expected rise to inflation.

Figures revealed recently show the decline in the mortgage market is gaining speed and it’s fuelled by the tight lending criteria and speculation over stamp duty.

Prices fell by 1.1% in just three months to June 2008, up from a 0.1% drop in the previous quarter. The annual house price inflation figures were down to just 0.6% nationwide in June and from 3% t in May, according to Department of Communities and Local Government (DCLG).

This now means that the average UK house price was nearly £216K in June, which is down by more than £1.6K in a month and £6K since the beginning of the year.

Gross mortgage lending went down 32%t during the last 12 months to June to £23.6 billion. The demand for new loans dropped by about 9% in just 4 weeks between May and June 2008, the CML found, while first time buyers and home movers borrowed 9% less money in June due largely to the tough lending requirements. The average homebuyer put down a 22% deposit in June, which is up from 20% in May.

Experts do not predict a change in fortune in the housing market any time soon, due partly to rumours of a stamp duty reprieve. Currently house buyers pay Government tax worth 1% of properties between £125K and £250K, 3% of properties up to £500K and 4% on any home worth more than that. Many tempted property buyers have since put their plans on hold due to the possibility of stamp duty being temporarily halted in the Government’s attempt to kick start the market.

How did it turn into a global credit crunch?

The way in which the debt was sold to investors gave the crisis a global significance.
The US banking sector sub-prime home loans turned into mortgage-backed securities known as CDOs (which means collateralized debt obligations). These were then sold to hedge funds and investment banks who had decided they would be a great way to generate some high returns (and large bonuses for the clever bankers that bought them). However, borrowers started to default on their loans and the value of the investments plummeted which resulted in huge losses for banks globally.

How did this affect the UK?

Many UK banks invested large sums of money in the U.S. sub-prime backed investments and have had
to write off billions of pounds in their losses. Then it got worse. Investors then became nervous about buying investment linked to mortgages, no matter how high their quality may be. Most of the UK’s banks had been using investment markets for fund large chunks of their mortgage business (this is a process known as securitisation). Fear spread and soon it became impossible to sell these investments which left a black hole in many banks/building societies’ finances. This resulted in a credit crunch due to lending dried up.

Have there been any winners in this?

It certainly isn’t us, as banks/ building societies found it tricky to raise funds on the money markets; they are forced to woo big savers who have been benefiting from some of the highest interest rates in a decade.

Continued falling house prices and stricter lending standards plus rising foreclosures have created a really vicious circle for struggling U.S. homeowners who have been sucked in to the growing numbers of borrowers who can neither sell their homes or cover their mortgage payments.

Through recent months, there have been more signs that even prime borrowers who represent the highest tier of credit worthiness in the mortgage market, are also beginning to feel the pinch. Only until recently, effects of the housing slump were most felt by overstretched homeowners who had taken out subprime or so called Alt-A mortgages.

Prime borrowers are now falling behind on their mortgages at more than 3x the rate they were in 2007, a pace exceeding the rate at which Alt-A / subprime borrowers are suddenly becoming newly delinquent on their mortgage loans, according to a report from Credit Suisse along with Loan Performance.

Prime loans make up almost 80% of the huge US mortgage market, which prompts fears that as delinquencies increase, there could be more pain in the US housing market before it can begin its recovery.

Since the housing market’s peak during 2006, house prices in both California and Florida have fallen by 20% and more, foreclosures have quadrupled and effects of the ensuing credit crunch has now meant that mortgages for new and existing borrowers are few and far between.

In simple terms this is a crisis caused by banks by being too nervous to lend money to us and each other. Where banks will lend they start to charge higher rates of interest to cover their own risk.

In our real world, that now means more expensive mortgages, increasing interest rates on credit cards, a lower interest for pension savers and other investors as the stock markets fluctuate wildly and with some of us, in the worst cases; more repossession and bankruptcy misery.

Is a cash crises the same as a recession?

A recession usually means 2 successive quarters of a negative economic growth. A credit crunch can be separate to or part of a recession but is entirely different.

Who invented credit crunch as a term?

No one is quite sure but it was used in a study by the America’s Federal Reserve Bank back in 1967.

What sparked the current cash crisis?

Many years of easy lending has inflated a huge debt as people continued to borrow cheap money and ploughed it into their property. Lenders were free with funds, particularly in the U.S., where billions of dollars of Ninja mortgages (people with no income, no job or assets who were allowed to borrow) were sold to people with terrible credit ratings (this was called sub-prime borrowers). The crazy notion was that if they ran into debt with their repayments then rising house prices would allow them to re-mortgage their property. It seemed like a good idea when Central Bank interest rates were very low, the tissue was it could not last.

Interest rates shot to rock bottom in America during 2004 at just 1%, but in June of the same year they began to rise again. As interest rates then jumped, US house prices had started to fall and borrowers then began to default on their mortgage payments which sparked big trouble for us all.

Now house sales in Scotland have slumped by 50% in the previous 12 months as a result of the credit crunch and there are raising fears that the country may be facing its first annual property price fall in more than ten years.

Properties that sold within days last year, at a time when mortgages of up to 120% were still available, are now staying on estate agents’ books for months as buyers now struggle to raise finance.

In the first 3 months of this year over 20K Scottish properties were sold, which was down from 18% from nearly 25K homes during the same period the previous year, according to online property guide- myhouseprice.com. The fall in 2008 against 2007 for April, May and June was 19%, with 24,245 houses sold in comparison with 30,067. An increasing number of houses are only selling after entering the market at a fixed price or after substantial price cuts. The online guide said that a fall in the value of properties in Scotland was “inevitable”.

The Scottish market to this point had avoided the house price slump which had already been seen in England, where volume of house sales fell 61% over the past year, but growth has slowed quite significantly and prices have fallen in various areas throughout Scotland including Renfrewshire, Highlands, Fife and Glasgow.

However, the public sector offers a safety net, helping to cushion the economy from a recession. The fiscal rules are currently being rewritten allowing for a much higher government borrowing.

The government has got the ability to take advantage of the gilt-edged market to tap into sovereign wealth and general international investment funds which are still in plentiful supply. Actually, it is one of the few UK borrowers that can actually access these markets. This will really help take the place of bank finance by funding the current account and (a little more indirectly), UK money and mortgage markets. In some ways it already has. The £27 billion used in the Northern Rock rescue last autumn was financed through selling gilts, many of these will have been bought through overseas investors.

Bank of England’s £50 billion special liquidity scheme was really meant to boost the inter-bank markets; however, at least it has provided some support for sterling and the housing market.

The Treasury is challenged in finding ways of easing the difficulties in adjustment. House prices have to fall back to an affordable level; however, it would be a mistake to allow them to fall back too far. If this happened it would plunge the high street and rest of the economy into a recession, hitting the exchequer very hard. It would also seriously impair house building capacity, reducing supplies and making housing way less affordable in years to come. The chancellor is considering stamp duty, but this may prove necessary in extending the special liquidity scheme in order to help the market to find a proper footing. Government support for banks will be hard for us to stomach, as they did lead us into this mess.

Though one way or another, it will be the taxpayer again who will end up with the bill.

Simply, if we can’t find a way of replacing international banking inflows and financing the deficit of the current account then domestic investment must fall and bank’s savings must increase to fund the shortfall. This may sound like a great thing and we should certainly start to save more. The problem is that this kind of adjustment is very hard to make very quickly and normally comes with recessionary side effects. An example of this is that the investment in housing is falling in response to mortgage famine; this is decimating jobs in construction, mortgage and other related industries. It now looks likely that we will see a recession rather than any rebalancing of the economy.

Market interest rates have now risen and our exchange rates have fallen as part of this adjustment. The current account has just begun to improve, largely due to the crisis hitting the profits that overseas banks are making in Britain. The slowing down in our economy has now also reduced imports. Exporters have now taken advantage of lower exchange rates – but through increasing prices rather than their production. Export volumes have grown by 1.5% during the year in the first quarter, whilst sterling export prices increased by nearly 8.5%. It seems that 10 years of high living and high exchange rates has started to take its toll on the export capacity.

An adjustment to the economy has further been complicated by the sudden surge in world food and energy prices. Now, household budgets are squeezed very tightly, making it more difficult for us to increase our savings. In the next week, it is likely we will see inflation topping 4% on consumer price index, taking another huge bite out of diminishing disposable incomes. It has squeezed company profit margins with much of the similar effects.

At the moment it is hard to see where a sudden increase in savings could come from.