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SIMON LAMBERT: The generation sat on a mortgage timebomb built from too high house prices and too low interest rates


Monopoly money: The Bank of England can't raise interest rates back to a normal level because people's mortgages are too big.

You can hardly move for timebombs these days.

Now Sir Mervyn King has added another to a ticking pile that already includes interest-only mortgages and bond funds - the huge homeloans of those in their 30s and 40s.

The outgoing Governor of the Bank of England warned interest rates cannot go back to normal any time soon, because of a generation that wouldn't be able to afford their mortgages.

He said: ‘The idea we are about to return to normal levels of interest rates is premature. One of the reasons we are not about to return is because so many households have such a high level of household debt'

Sir Mervyn's warning was subsequently echoed by a Bank of England report that predicted nearly one in ten mortgage borrowers would have to take significant action if rates were to rise by just one percentage point.

As we've highlighted before many of these borrowers have interest-only mortgages, where they are paying none of the debt back.

However, even many of those on repayment mortgages who have stretched as far as they can go to put a roof over their head, can't really afford rates to rise.

The irony, of course, is that this timebomb has been built with an incendiary combination of too high house prices and too low interest rates and it is the Bank of England's Monetary Policy Committee that sets the latter.

To be fair to Sir Mervyn King, he has been one of the few figures of financial authority in the UK to have repeatedly warned of these problems, throughout boom and bust.

Unfortunately, however, the MPC ratesetters have no remit to tackle house price inflation and so prices were allowed to spiral during the 2000 to 2007 boom.

Throughout this time Chancellor Gordon Brown was happy to stand by and celebrate his miracle of consumer economy growth, artificially turbo-boosted by a nation cashing in on rising property values through remortgaging and then splashing out with the proceeds.

These were golden days for anyone selling kitchens, conservatories, sports cars, plush sofas and big televisions.

Expensive: House prices are still considerably above the long-term average ratio to earnings, Nationwide's chart shows, and this average line has been pulled upwards by the boom from 2000 to 2007.

Those who are paying the biggest price for this madness are the ones who derived the least benefit.

Homeowners who were already in reasonably substantial properties as the millenium

struck, or who got into them near property boom ground level in the early 2000s, saw house prices rise so far that their mortgages have been dwarfed.


In theory, when rates are as low as they are now it makes sense to borrow as much as you can on the cheapest rate to get the biggest home you can afford, but there are a couple of crucial caveats.

Firstly, you need to make sure you can afford the repayments not just on a 3 per cent mortgage but also on a 6 per cent one.

Secondly, the other half of such a theory is that you also need to be willing to cut your mortgage and downsize to an inferior property when rates go up.

Those who got in nearer the end of the boom, or who have had to trade their way up the property ladder since, are the generation in their 30s and 40s with the massive mortgages that Sir Mervyn  is warning about.

These borrowers faced a stark choice, risk borrowing to the hilt to buy overpriced housing, or give up on all hope of homeownership.

These are the families with mortgages four times as large as their parents' generation ever had, simply to own a property a quarter of the size.

The problem has been exacerbated by the property bubble that was allowed to inflate and was then never allowed to properly burst, as the pain was deemed too much for our economy to take.

If you are starting from a point where property is near the top of its historic range in terms of the relationship to earnings, then the common sense way to make homes affordable is for their prices to come down.

But in Britain we have decided that involves too much collateral damage. So instead we relentlessly come up with new ways to try and stretch our limited means even further to keep buying expensive homes.

Paradoxically, we now face a situation where the Bank of England is dishing out cheap funds to encourage more low rate mortgages, while warning of the perils of borrowing big on cheap money.

At the same time Chancellor George Osborne's big plan to revive the economy is to reflate the property market.

It's hair of the dog economics. What could possibly go wrong?

Rocketing: House prices have soared in recent decades, driven first by mortgage deregulation in the 1980s, then by the cheap credit boom of the 1997 to 2007 decade. Since the 2007 peak they have been supported by record low interest rates.

Category: Credit

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