There May Be Trouble Ahead
There may be trouble ahead: The sub-prime lending market and the impending residential property market crash? A recent investigation found evidence of serious mis selling in Britain’s sub-prime mortgage market.
If the sub prime market starts to fall apart with more and more borrowers defaulting then a domino effect may lead to a flattening of residential property values and potentially a crash. We may even see borrowers’ mortgages becoming larger than the value of their properties: ie negative equity.
Self certification is one example of "sub prime" lending, where lenders usually charge higher interest rates than standard ( or should we say "prime" ) lenders. The investigation discovered that home purchasers were encouraged to lie about their incomes on mortgage application forms so as to take out larger loans. These borrowers are more likely to default on their mortgages as the repayments are relatively more expensive and often they have borrowed the full amount of the purchase price of their property. These 100% mortgages are another example of sub prime lending.
But how does any decline actually spiral into a crash? Is this scare mongering on the part of the press? Well the theory goes that if the sub-prime market falls apart, more borrowers default and their properties are repossessed and sold. Suddenly more properties are on the market.
At the same time lenders become more cautious and are more risk adverse. Mortgages become harder to come by and suddenly there are less buyers about. Now with the economics of supply and demand taking effect: more properties and less buyers means falling prices. Throw in a lack of confidence in the market and suddenly a fall becomes a crash. It is never as simple as that and there will be pockets ( the higher end of the market perhaps) where different economics apply.
That is the theory; but has the first domino fallen already? That is a more difficult question to answer. However there IS concern about the sub-prime market AND repossessions are up: According to the Royal Institute of Chartered Surveyors some 45,000 properties are likely to be repossessed next year. If you want an idea of what lies ahead for the property market in the South West then look at the sales figures for property auctions....and they are on the decline.
So the signs are not looking too good although it is probably too early to tell and after
all commentators have predicted a fall in residential property values for some time now.
The key factor, in my view, is interest rates. If mortgage interest rates increase then this puts pressure on borrowers and more of them will default creating more repossessions. If interest rates do not increase then it is easier for borrowers to manage their budgets.
Rising interest rates have accompanied all previous property crashes. So if the banks and building societies put up their interest rates that is the time to worry. Most telling perhaps is the Bank of England did not increase the interest base rate this month but the mortgage lenders increased their rates. Interesting indeed!
Friday, 05 October 2007
