Cash injection

Posted by: Jules Birch

02/09/2010

Why haven’t record low interest rates generated more of a boom in the housing market than the one that’s now hit the buffers?

The latest Nationwide index published this morning shows that prices fell 0.9% in August following a 0.5% fall in July. Until now it has reported markedly more buoyant results than the rival Halifax index. 

Comparing the Nationwide’s last three months with the previous three, prices flat-lined and anything other than a sizeable increase in September will see that measure enter negative territory for the first time since May 2009. The annual rate fell to 3.9% from 6.6% a month and that too could go negative within the next few months on current trends. 

But all this is happening at a time when home owners are substantially better off. In September 2008, the average interest rate for a variable rate mortgage was 5.9%. It’s now just 2.8%.

That means anyone taking out a 75% mortgage on a house priced at the Nationwide’s current average of £166,507 is now paying £579 a month rather than £796 a month. They are £217 a month or £2,604 better off. (Compare that to the £600 a year cuts facing tenants on housing benefit). 

Nationwide says the falls are due to the unwinding of the supply-demand imbalance that drove up prices last year. Rising prices encouraged sellers back into the market and buyers have more bargaining power. The falls are a correction in a market that had got ahead of the recovery in the wider economy.

Another big reason is the sclerosis in the mortgage market and lack of entrants. First-time buyers are finding it virtually impossible to get a mortgage without family help with a deposit and Bank of England figures earlier this week showed a slump in mortgage approvals. 

A third is fear of the austerity budget and possible double-dip recession to come. There are better ways to use that £2,604 a year than to buy a more expensive house that may fall in value. 

But underlying it all in my view is that house prices are still fundamentally over-valued against incomes. That injection of cash into the pockets of home owners concealed it for a while but now it’s reasserting itself. 

That does not mean that prices are about to fall as they did in 2008 but it does mean that any increase in interest rates will have a huge impact. It may not happen until well into 2011, as Nationwide believes, but sooner or later it will.