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Britain’s very own sub-prime housing crisis

The credit crunch in the global financial system is now beginning to interact with the British housing market. Lax credit conditions that allowed prices to spiral are drawing to an end and many home owners are staring at sharp increases in their mortgage repayments. Record outstanding debts of £1,400 billion and low savings rates all weigh heavily on the property market. Experts are warning of a dramatic fall in house prices ahead.

Britain has its very own sub-prime crisis, which has already wrecked the US houing market and sparked the credit crunch. Large but unknown numbers of people have fallen prey to commission-based “financial advisers” and mortgage brokers who lured them into loans on properties far beyond their means. Using self-certification of income, these middlemen encouraged people to grossly overstate their income so as to qualify for the massive loans secured on over-valued property.

Rapidly rising house prices gave the impression of higher values, enabling people to borrow against the market price of their homes, increasing their existing loan. Now tens of thousands have sunk into even greater debt, overwhelmed by repayment demands. As the small print says, your home is in danger if you do not keep up the payments and repossessions are rising.

That is not the end of this particular story. An estimated 2 million poorer borrowers are on lower, introductory fixed-rate mortgages which were an extra inducement. These are drawing to a close and people with this kind of a mortgage face a staggering 60% rise in housing costs in the coming months as interest rates are readjusted, according to the credit ratings agency Standard and Poor.

The buy-to-let business has also boomed in the past five years. The number of such mortgages more than quadrupled as increasing numbers of people came to regard it as the dependable alternative to uncertain savings and pensions. In this speculative market, reckless profiteering combined with loose credit for mortgages has led to such drastic overvaluation of property that, as interest rates have risen, repayments on loans in many cases far exceed rental income.

At the heart of this problem is "creative financing", enabling buy-to-let investors to borrow 100% of the cost of their new properties - not the 85% maximum most lenders permit. With 85% loans, investors have to come up with money of their own, and so are limited in how much they can buy. But with 100% mortgages, the brakes are off and there's effectively no limit.

The "creative financing" was made possible by discounts - typically 15% or more - which property developers offered to buy-to-let investors who bought flats in bulk. It helped power a construction boom as new blocks of flats and apartments mushroomed in city centres for the buy-to-let market. With interest rates up, and the market oversupplied, prices are starting to fall sharply outside London, leaving property owners and their loan companies in deep trouble.

The more than £8 billion that Northern Rock has borrowed of the unlimited support provided by the Bank of England since its crisis erupted two weeks ago, will soon look like the summit of a much larger mountain of unrepayable debt. Meanwhile, with New Labour’s financial support, the bank continues to offer 125% mortgage and personal loan packages, whilst refusing to support applications for personal bankruptcy from its overstretched customers.

Decades of persuasion to “get on the property ladder”, declining social housing, the sale of council housing and a decline in affordable private rented accommodation together with historically unprecedented, impossibly easy credit have lured millions into levels of debt that can’t be repaid within their lifetime.

Gerry Gold
AWTW economics editor
2 October 2007

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