Banks and watchdogs risk a housing market catastrophe

Who can doubt it when we are told that the housing market is finally about to cave in under our feet, and the world will never be the same again?

Well, I for one. Some commentators, and worryingly regulators, seem to have forgotten that the housing market, just like the seasons, is cyclical.

Each cycle is different, and some staging posts in the cycle are far more pleasant and comfortable places to be sitting than others.

According to the Nationwide, prices fell for the fourth month running in February, slashing annual inflation to 2.7%. This has prompted analysts at Capital Economics to predict that in a couple of months house prices will be in negative growth. They are probably right.

Elsewhere, Hector Sants, Financial Services Authority boss, warned that the credit crunch has torn up the mortgage map forever, pushing up the cost of borrowing and making a painful period of readjustment inevitable. He is probably right too, up to a point.

He seems to have forgotten that the seasons turn, turn, turn. When we talk about this winter’s gale force winds, floods and earthquake, we should remember that we also enjoyed the sunniest February on record. In other words, it’s been a mixed bag, just like the UK housing market.

And how this performs in the months to come will depend very much on how our big finance houses and the watchdogs that regulate them decide to behave.

The outlook isn’t too encouraging, certainly in the short term. A number of institutions, including Nationwide, last week made life much harder for first-time buyers. Britain’s biggest building society already charged those borrowing more than 95% of the value of a property 0.6% more than other customers.

It has now introduced a new levy: if you want to borrow between 75% and 95% of the value of a property you will pay 0.2% more than those who have deposits of at least 25%.

To be fair, there are two ways of looking at this. At one level it could be argued the society is doing young borrowers a favour.

The current market, with the prospect of further house price falls, is not one in which first-time buyers should be playing. They are well advised to stay out of it until this current storm has passed.

Nationwide is not alone. C&G has stopped lending above 90% completely and Skipton has limited its offers to those with a deposit of more than 25%.

On the other hand, this is a serious penalty for borrowers trapped in the market with low or no equity, particularly if prices fall further in their area. They will find themselves facing hefty increases in repayments when they come off their current mortgage deals.

Relationships formed in a hurry with an eye to rising house prices will soon crumble. Repossessions will soar. That’s the doomsday scenario, and one to which Scotland is far from immune.

Commentators expect the Scottish market to hold up better than most of the rest of the UK, but a major crash cannot be ruled out. Home ownership in Scotland has reached historic highs, and prices in many of our cities have had unprecedented booms.

But none of this has to be. Banks tell me they have been forced to limit the numbers of high-risk borrowers on their books because of the short-term funding difficulties.

This is only partly true. Some institutions are awash with funds. These have pushed up prices because their admin can’t cope with the flood of customers hammering at the door.

There are still decent deals around. Charcol has a Newcastle two-year fixed at 5.25% for those who need to borrow 95%. Co-op will lend at 0.39% above base. The Abbey will fix your rate for two years at 5.43% with a 10% deposit. All with a £999 fee and no higher lending penalty.

Provided more lenders return to sensible lending criteria at the first opportunity, property Armageddon should be avoided. But if they continue to take fright at the thought that prices may fall and lose confidence in their ability to sensibly assess a good loan risk, irrespective of the size of the deposits, then the outcome could be catastrophic.

The biggest worry is how the FSA will respond, and here the portents are not good. When it screwed up over Equitable, it vented its anger on the life insurance industry. Let’s hope its guilty conscience over Northern Rock doesn’t lead to it punishing mortgage companies with draconian new restrictions – and disastrous consequences for us all.

Published Date: 02 March 2008 Source: Scotland On Sunday, Teresa Hunter