Burning down the house – The New European
Most of us have only a vague idea at best of what gilts are – a term for UK government debt – or how market confidence in government affects the FTSE or our chances of find a job. But where many families will feel the consequences of the government’s economic mismanagement directly is in the mortgage market – and that doesn’t look good to anyone. Surprisingly, even those who don’t have a mortgage themselves can be negatively affected by what happened.
If this were a L’Oreal ad, we’d do the science part now – too often explanations of what’s going on assume that every newspaper reader understands labor economics. But it forces us to try to figure out why a statement about tax cuts suddenly means our mortgage bill is going up.
The first thing to know is that the Bank of England is truly independent of the government, and has been since 1997. It has a few key mandates, foremost among which is trying to keep inflation around 2% – which it is clearly with struggling.
When inflation is high, the Bank responds by raising interest rates, which aims to take money out of the economy and slow it down. It works by making savings more attractive because the returns are higher. It also makes borrowing and debt repayment more expensive. In some extreme cases, such as in the early 1980s, high interest rates can lead to recession.
The Bank withdraws “surplus” money from the economy in order to reduce inflation. This is a controversial approach when inflation is caused by an energy supply shock, as few families feel like they have a lot of cash on hand right now. But that’s the orthodoxy the Bank is bound to subscribe to, and interest rates were already rising before energy costs started to rise.
It’s worth remembering that the Truss-Kwarteng emergency budget didn’t need to be in place – the hugely expensive energy bill bailout had already been announced, and even though the markets didn’t like this they generally felt was necessary and accepted without panic.
What spooked the market was the announcement of a further £45bn in tax cuts, of which only £2bn was subsequently reversed. This had two negative effects. One was to raise the cost of government borrowing (gilts) as markets now feared the new government would care about fiscal responsibility.
These £43billion in tax cuts mean the government is pumping another £43billion into the economy – an economy which, from an inflationary point of view, already contains ‘too much’ money. The government is stepping on the accelerator just as the Bank of England is stepping on the brakes – which does no good for the engine.
The Bank of England has not met since the emergency budget and has yet to raise rates. But because the market expects them to do so, they act preemptively. If you are a bank and you know the cost of borrowing is going to increase next month, why lend money at a loss this month?
This is exactly what mortgage lenders have done. More than 1,600 mortgage deals disappeared from the UK mortgage market following the emergency budget, with some of them reappearing at much higher rates.
Some people with existing fixed contracts only pay 1% interest per year. New fixed rate transactions in the UK are now around 6% interest per annum, which is a considerable increase. Monthly bills will increase accordingly.
Seniors might shrug their shoulders when they remember that during the mortgage crisis of the early 1990s, interest rates hit 15%. But that’s forgetting that back then, house prices were much lower in absolute and relative terms. Because house prices – and therefore mortgage debt – are so much higher now relative to wages, a mortgage with an interest rate of 6% today is almost as crushing as a mortgage of 15% in the past. ‘era.
There are approximately two million households that will have to remortgage over the next two years. They will all face a dramatic increase in the cost of their repayments, with some facing monthly repayments more than double what they are currently paying.
But the problem is even more acute than that: banks are obliged to ensure that borrowers would be able to repay their loan if interest rates rose even higher. These repayment stress tests were until recently considered too strict, forcing banks to check whether borrowers could pay their mortgages if the base rate increased by three percentage points.
This kind of hike seemed incredibly huge when base rates were down to 0.5%, but in reality it turned out to be too small – the expected rate hikes are now much bigger than that. As a result, Nationwide now uses 8% interest rates as an affordability test for most buyers, with a slightly lower threshold of 7% for first-time buyers.
They may not be the friendliest people out there, but the problem is even more acute for rental owners. Almost all buy-tolet mortgages are interest-only, with no repayment on the money actually borrowed, which means that if property prices don’t rise, the homeowner doesn’t accumulate any capital.
On top of that, even though the payments start lower, they are much more sensitive to interest rate increases. A buy-to-let owner may currently still have a mortgage with an interest rate of 1%, but may face a rate of 5% when it comes to re-mortgaging.
At 1%, a loan of £250,000 would accumulate £2,500 a year, which means repayments of just over £200 a month. At 5%, that same loan accrues £12,500 in interest each year, meaning repayments add up to over £1,000 a month.
That doesn’t leave a typical owner with many options. Surely they should at least try to raise the rent. If they have equity in the property, they can try to sell – but not if the price has dropped so much that they are in negative equity.
But tenants looking to buy would face the same high interest rates that force the landlord to sell. In contrast, a cash-paying overseas buyer benefits not only from falling house prices, but also from a falling British pound. For overseas cash buyers looking to become homeowners in the UK, the current crisis is definitely an opportunity. For everyone else, it’s just a crisis.
Many additional factors complicate the picture: condominiums didn’t really exist as a model during the last housing crisis, but make it much, much harder for people to leave a property they can’t afford.
We also have the somewhat bizarre situation of the government offering guarantees to banks on 95% mortgages to first-time buyers, at a time when these buyers could very easily find themselves trapped in negative equity or by future price hikes. rate. The grants are due to expire at the end of the year, but lenders, predictably, are warning their withdrawal could end all offers for first-time buyers.
Anyone with any recollection of recent economic history will recall that it was mortgages that caused the last financial crisis – albeit this time in the form of bizarre financial products based on American subprime mortgages.
For a typical household, the mortgage is the biggest debt and the biggest monthly expense. People who spent all summer worrying about paying their energy bills this winter now also have to worry about the mortgage — or next year’s rent.
This is a situation in which some sort of intervention will be needed to prevent a collapse. The question is how badly a battle will turn out with ministers. Protecting mortgages and house prices has been the Conservative Party’s defining mantra for decades, but this is a government that (often accidentally) sets sacred cows on fire.
It will take time and finesse to find ways to avoid large-scale defaults and negative equity, especially in a way that doesn’t lead to further inflation and even more interest rate hikes. ‘interest. This can be best achieved with planning and consultation – instead of letting the problem reach a full-scale crisis point and rushing something together.
It all sounds doable – until you remember who’s responsible.