The media is currently full of speculation that the Monetary Policy Committee (MPC) is set to embark upon a course of interest rate hikes, in an effort to stem inflationary pressure in the economy. Charged with keeping a lid on inflation, it is committed to using rates as the primary method to cool the over-heated UK consumer.
However, while use of interest rates in this manner can be explained in the wider economic picture, I wonder how relevant is it to the housing and mortgage sectors? It could be that raising interest rates will persuade borrowers to veer away from paying the extraordinary prices now sought by home-owners for their properties.
Double digit annual house price rises over the past year have fuelled concerns, especially when viewed alongside the continuing high street boom. But my view is that, rather than using interest rates, the only thing that will correct runaway inflation in house prices is the market itself.
Most commentators say that the present situation is ultimately unsustainable. But thinking that rate rises alone will deliver the correction is folly. The market will, as history has demonstrated, correct itself and it will be based upon the borrower judging whether the prices being asked for property are affordable. They will have to assess whether they can afford their housing commitments. When people start refusing to pay the huge prices being asked demand will slow and the runaway market will correct itself to a level that is deemed appropriate and sensible. The only true rule in market economics is not to interfere and let the market find its own level.
Mortgage lenders have clear responsibilities to act prudently and lend sensibly with enough safeguards and checks to meet these objectives. They only lend money against a set of criteria: income multiples, LTV level and an assessment of the amount borrowed in relation to the property valuation. While income multiples have crept up in recent times, this is in response to the current low rate environment and is essentially a secondary issue.
There are two basic issues here. First, people are simply not making enough provision for repayment at the end of the term, if they have an interest-only mortgage. We are already starting to see a problem with endowment shortfalls, and this problem is bound to worsen if stock markets continue to be sluggish.
Second, at a time of sharply rising prices, it is easy to assume prices will always rise at the same rate and that there will be plenty of equity in the property at a later date. This is far from true, as evidenced by the 10 years of stagnant property prices from the late 1980s to the late 1990s. High current prices will not automatically mean a large pot of profit in the future.
It is borrowers’ responsibility to judge they are not buying something that is overpriced and they can afford to pay for it. Small incremental changes in base rate the MPC is likely to make are unlikley to have any effect on the state of property prices.
John Prust is sales and marketing director at SPML