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“Declines in European house prices are clearly possible and in some countries even likely; where interest rates will go next is uncertain”, writes David Miles, chief UK economist at Morgan Stanley.
What kind of home loan will best suit today’s property market where house prices are higher relative to incomes, but may be volatile and cannot be assumed to carry on rising?
David Miles, chief UK economist at Morgan Stanley and one of the leading commentators on the mortgage market, will answer your questions on the European mortgage market in a live online debate today from 3-4pm BST. Post a question now to firstname.lastname@example.org or use the online submissions form below.
When should a middle class first time buyer in the UK take the plunge into the property market and what sort of rate will be favourable for the average worker in London? Should we wait for six months and see or will the wait only make the house prices rise and be detrimental to us?
Mohit Sial, London
David Miles: I suspect that we have not yet seen more than a small part of the effect of the five interest rate increases from the Bank of England which began less than a year ago. It is likely - though far from certain - that over the next six to 12 months the impact of those interest rate rises will feed through significantly as the cost of repayments on mortgages moves higher for millions of borrowers.
In the light of that the timing of becoming a home owner in the UK is very tricky - probably it always is. My own view is that no one should feel they have to get into the market as soon as possible for fear of missing out - it is not as if house prices look exceptionally cheap in the UK!
Would the introduction of fixed rate mortgages in the UK (as in the 2004 Miles Report) not be conducive to a housing bubble in the UK as lenders making these loans looked to lend against future earnings post inflation rather than current, effectively giving rise to much higher salary multiples?
Ashley Stuart, London
David Miles: I don’t think that lenders who offer longer term fixed rate mortgages pay any less attention to the affordability of the mortgage based on people’s current salary. So I doubt whether you would see much higher income multiples on longer term fixed rate mortgages. What fixing the rate for longer does is, of course, make the money value of the repayments far more predictable. It also means that mortgages look less cheap and affordable than variable rate mortgages when short term interest rates have fallen to unusually low levels that are not likely (and are not seen to be likely in the financial markets) to be sustainable.
Can the British mortgage/financial system handle a similar subprime market problem we’re seeing in the US? Are there greater safeguards in place here?
Mark Faith, North Wales
David Miles: I think that what we sometimes call UK subprime mortgages are rather different animals from US subprime mortgages. In the UK people with patchy credit histories, or with sketchy details of their incomes, can generally borrow less than has been the case in the US and, as a result, may face less affordability issues a few years later.
So I suspect - and hope - that the scale of arrears and defaults on what we call subprime mortgages in the UK is likely to be less serious than what we are seeing in the US.
Having said that I do find worrying the evidence that the Financial Services Authority (FSA) found recently about the way that mortgages are sold to people who are considered sub-prime. (The FSA press release of July 4 summarises the findings). They found that there was evidence of less attention being paid to affordability issues than one would hope. This will be a continuing concern as the impact of recent rises in interest rates and in house prices plays out.
Can the European mortgage market be further influenced by the fact that London is becoming a financial capital of the world at the time when New York is losing grounds as a result of stagnation of the US economy associated with the high oil prices, weak dollar, Sarbanes-Oxley act imposed limitations on the American corporate world, mortgage/education loans repayment problems in the US?
Viktor O. Ledenyov, Ukraine
David Miles: I am doubtful that there is much connection with London’s position as a global financial centre and the evolution of mortgage markets in Europe.
What is notable in Europe is that while the wholesale financial markets are very well integrated, the retail mortgages markets are still fairly national. To be honest the idea that German households will come to see advantages in UK style (variable rate) mortgages because of the position of the City of London is not very likely.
Having said that I still do see advantages with so-called index linked mortgages. And it is true that trading in index linked government debt is far more significant in London than in any other financial centre in Europe. So if we did see an emerging trend to using index linked mortgages it could well be that much of the resulting trading in index-linked bonds (created using indexed mortgages) went through London.
Do you believe that the US will begin to offer index mortgages?
Rob Ricci, Washington DC
David Miles: The question has come up before and to date the products have not been offered (or at least if they have they have not been very popular). One reason why people may have been wary is because of the prospect of negative-amortisation; this is a situation where the nominal (dollar value) of debt outstanding can go up from one year to the next.
People get nervous about this - both lenders and households. Economists scratch their heads about why people get so agitated on negative-amortisation since in real terms (after allowing for inflation) the outstanding debt does not rise - indeed with a standard repayment mortgage it will always fall in real terms. I suspect this fear of negative-amortisation - and a suspicion that there is something a bit fishy about a contract where you don’t know the dollar value of repayments on the mortgage from one year to the next - will mean that index mortgages will only emerge slowly.
But I still think they are a good idea!
Generally speaking the UK mortgage market is more flexible in lending attitudes than the European neighbours. Do you think the European markets will start to follow the UK lead or perhaps the UK rules will tighten up and self-certification (for example) will vanish from the list of available products.
Richard Johnson, Enfield
David Miles: I suspect a bit of both. I think we are already beginning to see many lenders in the UK taking a more cautious view on affordability and on the reliability of people’s income details. As house prices and interest rates have risen, and as arrears and re-possessions statistics have worsened, lenders are less willing to take risks than they were a year or so ago. This represents a tightening of credit conditions and I suspect it has some way to go.
As you say in many European countries the availability of credit - particularly to people with patchy credit histories - has been less than in the UK. This may change a bit. But I guess that lenders in some other countries might look at the UK figures on household insolvencies and arrears with mortgage payments and be wary.
I realise that, certainly in the UK, less than 1 per cent of the housing stock is built each year. However, much of the existing stock is improved in terms of quality or size of the home, improving the fundamentals of the underlying asset. To what extent does this affect the property market and how is this taken into account in analysis of price changes?
Michael Hill-King, London
David Miles: That is a very good question. The value of improvements is not at all well measured in the statistics. House price measures - for example those provided by the Nationwide and the Halifax - look at the prices paid for houses sold and compares that with the prices paid for similar houses in the past. That is the basis for people’s assessment of house price inflation.
This means that some part of what we call house price inflation is really a reflection of improvements - or investment. Of course in some cases this cuts the other way - if a house falls into disrepair and is sold for less than it was worth a few years earlier this shows up as a fall in price (rather than a form of depreciation due to neglect).
Overall I suspect that these effects are not very large though - and the impact they have is quite steady from one year to the next so that big fluctuations in measured house price inflation is really driven by true inflation rather than improvements.
Could you tell me whether another interest rise is likely in the near future. If yes, when and how much?
David Miles: The honest answer is, of course, that no one knows where interest rates will go in the UK - not even the members of the Monetary Policy Committee at the Bank of England who make the decisions on interest rates.
I expect it will be a close decision at each of their meetings over the next three to four months as to whether interest rates need to go a bit higher. My personal best guess is that rates may not move higher. But I would certainly not bet (much) on that.
Anyone thinking of borrowing a lot of money and gambling that interest rates will not go higher is very clearly taking a big risk.
Isn’t the issue with indexed and fixed rate mortgages that they lessen considerably the impact of rate rises as a tool by central bankers to control inflation?
David Miles: They may have that effect - though there will remain many mechanisms by which changing short term nominal interest rates affects the economy. And of course even if many people were to start taking out indexed mortgages the existing stock of mortgages in the UK will remain overwhelmingly on nominal interest rate debt contracts for many years.
But I do not believe it makes the job of the Bank of England at all easy having a large part of the impact of interest rate changes channelled through the housing market.
Do you think Gordon Brown’s plan for more 25 year mortgages will help stop the volatility in the British mortgage market?
Peter O’Donovan, London
David Miles: I do believe we have difficulties in the UK because many people attach a great deal of weight - and probably far too much weight - to the cost and affordability of mortgages at whatever the current level of short term nominal interest rates is. I think this has been a contributory factor to the volatility in house prices in recent decades.
If people were encouraged to focus on the average cost of mortgage debt over several years then I think the risk situation would be better and the housing market would be less volatile. People assessing the cost of mortgages in a more forward looking way might also mean more longer term fixed rate mortgages were sold.
The fundamental point is about helping and encouraging a more forward looking assessment of affordability and risks - and people deciding to take out more longer term fixed rate mortgages might be a side effect of that.
The move towards a more sustainable source of funding would be at rate of interest likely to be higher than the current yield housing offers; this would imply significant falls in house values. This will be unpopular with a majority of the public, and politically unpalatable. My expectation would be that you would find lots of public applause from politicians, but behind the scenes scuppering of your plans because they do not fit into the populist political agenda. I also think that the idea may be too complex for many homeowners to comprehend. Do you think these are the issues you are likely to come across, which, sadly, may significantly delay, if not destroy attempts to encourage such as system? Will we have to have a sustained fall in house prices before this theory is really taken on board?
Neil Smith, London
David Miles: I don’t believe the cost of index linked mortgages would mean that debt was more costly than it is today. In fact the initial cost of servicing mortgage debt is very likely lower with indexed debt where it is the real, and not the nominal, interest rate that determines the initial repayments. Today real interest rates are about half the level of nominal interest rates.
Are fixed interest rate mortgage loans available in the UK? If so, what would be the typical interest rate of a 15 year loan? And what is the typical maturity term of a mortgage loan in the UK (15-20 years)?
David Miles: Yes, there are many fixed rate mortgages available in the UK - certainly with rates fixed up to 10 years. Fewer lenders offer deals with rates fixed for beyond 10 years - though even here you can find easily mortgages with rates fixed for 15, 20 and even 25 years. At the moment it is possible to get 15 year fixed rate mortgages at rates fairly close to 6 per cent - which is not very much above the rate on mortgages with rates fixed for much less time. But those mortgages often do have some charges if you were to repay most of the debt early. Though at the same time they allow (usually) you to take the mortgage to another property.
Usually in the UK people take out mortgages with an original maturity of 25 years - though there are very many mortgages which are interest only with no explicit mortgage repayment schedule