A decade-long party for homeowners is coming to an end. The cost of repaying mortgages in the UK, Europe and the US is skyrocketing at the same time that disposable incomes are being squeezed, and expectations of an economic recession and house price crash are becoming commonplace.
Last week, Knight Frank predicted a 10% drop in London house prices over the next two years. It’s a highly unusual move for realtors and adds to independent analysis and bank forecasts of a decline across the UK at least.
How could a housing market that has felt nothing but rising prices over the last decade slip into crash territory?
The 2008 financial crisis taught us a hard lesson about the dangers of over-borrowing mortgages.
At the time, about one-seventh of mortgages were highly leveraged, with a loan-to-value ratio of over 90%. Since then, banks have tightened their lending standards, with only 4% of banks borrowing at the same level.
Today’s borrowers must raise relatively large deposits and demonstrate that they can withstand rising interest rates. Reckless lending is largely contained, reducing the risk of homeowners going into negative wealth.
Another key feature of the last decade has been low interest rates. This allowed buyers to underwrite large mortgages at low monthly costs.
Instead, anyone who could pile up their savings could afford to buy a more expensive property, and as long as interest rates were kept low and the term of the mortgage was long enough, they could bet on repayment. Low interest rates effectively made larger homes affordable, pushing up housing prices in return and crowding out people who couldn’t raise cash for deposits or access “Mom and Dad’s Bank.”
However, interest rates have soared this year, with the Federal Reserve raising the base rate from 0.25% to 3.25%, followed by the Bank of England and the ECB. Trying to contain runaway inflation.
Suddenly, that affordable image changed dramatically.
“Until just a few months ago, we were talking about interest rates. [in the UK] Given the affordability, a reduction of up to 3% would be difficult. The market is now expecting mortgage rates to rise to around 6%,” said Noble Francis, economics director for the Construction Products Association.
The rise in interest rates had an immediate effect. UK mortgage lenders rushed to pull back on products after Prime Minister Kwasi Kwarten’s tax cut ‘mini’ budget last month raised expectations of higher interest rates.
As a result, anyone buying a home in the UK today faces much higher mortgage borrowing costs. Mortgage payments average about 17% of a first-time buyer’s income, according to data from consulting firm BuiltPlace.
But it’s not just for people just starting out with property ownership. Some effects are more gradual. Every month, tens or hundreds of thousands of homeowners in the UK have to cancel their fixed-term contracts and refinance their mortgages. In that case, you will face costs much higher than what you are currently paying, and some may be forced to sell.
“It’s a perfect storm for homeowners who bought a home in the last decade and aren’t used to high mortgage rates, at a time when the majority of people are likely to endure falling real wages,” Francis said. said.
There are signs that rising borrowing costs are already impacting demand for new homes, with property portal Rightmove reporting a recent average drop in activity from potential buyers last week. It’s modest.
Declining demand will reduce deals in the UK from an already low base by historical standards. This means that the data can be distorted by
“It will reveal a much less traded housing market dominated by need-based movers and the rich,” said Lucien Cooke, head of UK housing research at realtor Savills.
In the US, there is already evidence of heat from the sales market, with transaction volumes declining in some of the largest cities.
An FT analysis of data through the end of July 2022, provided by real estate firm Zillow, shows monthly growth in U.S. home sales has slowed from a post-pandemic rebound high of 4.4% in mid-2021. It has been. , down to a low of -2.2% on a 12-month rolling basis.
Death, debt and divorce are frequently cited as the three biggest drivers of sales by real estate agents, but there are few incentives to sell in a declining market, other than necessity. But higher re-mortgage costs could put some homeowners under pressure to bargain, lowering the average price set by recorded deals.
Declining sales, rising affordability and homeowner pressure to re-encumber could trigger painful price adjustments in the UK, US and elsewhere.
In the aftermath of Kwarteng’s budget, multiple projections suggest that average UK house prices will fall by more than 10% in nominal terms over the next two years. Thanks to the surge in prices during the pandemic, even if there is a sharp drop, prices will only return to the levels recorded in May 2021.
But the results can be disastrous, especially for those who bought them recently. Inflation remains so high in the US and Europe that when nominal prices fall by 10%, he is effectively down by nearly 25%. This is a bigger drop than the painful correction that followed the financial crisis.
Data visualization by Steven Bernard and Patrick Mathurin