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Mortgages: The Dark Side

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By - Thursday 28 July 2011

Mortgages: The Dark Side

Whilst I am not a qualified statistician, nor a particular maths whiz, I have been told I tend to have a rather linear and logical thought process – a thought process that I will attempt to apply to the UK housing market in a bid to highlight the current problems, why they exist and what can or could be done about it.

UK house prices rocketed until roughly 2007, as did mortgage lending – largely due to higher LTV availability.

The banks (in their very misguided belief, trust in the extrapolation of graphs and complete failure to heed their own warnings of "past performance is no reflection on future returns") thought to themselves something along the lines of the following:

Joe Public sees property as a mainstay as far as long-term investment value is concerned – house prices always go up over the long term. This being the case (which the rest of the world knows is not) the marketing departments at the banks came up with something along the lines of "why don't we lend people money that doesn't exist, against a property that we know will increase in value?"

The fundamental problem is very quickly apparent when you look at the statement above and begs the question why were the banks allowed to structure and create lending products in this fashion?

The answer is simple – there is no regulation restricting what criteria the banks must use when it comes to assessing the potential value of a property.

There is such regulation in other investment areas – take gold for example. Gold has been going to the moon for quite sometime now – hardly an analyst on the planet has a bad word to say about it. The same applies to oil and silver, and yet lending against these commodities is not permitted over any substantial time. (You can use leverage on trading, but not for a sustained period of time)

So why is lending not permitted against these "dead cert" investments?

Simple – risk.

The commodities market can move at an incredibly rapid rate, much like stocks and shares and yet if you trundle down to see your bank manager and ask him for a mortgage to buy some gold or crude, he'll likely look at you as though you had just asked him to hurricane-proof a budgie using only a pair of used tooth-picks and half a pint of freshly squeezed kumquat juice.

After his initial shock and awe, your bank manager will explain in very tedious detail that such a thing is not possible for various reasons; mainly that it is too risky, not legal and just cannot be done.

Comparisons

Once you have sat through the very complicated explanations, one can expect to be perhaps a little confused – if we look back over the past few years we can see that property has risen by around 100%, and yet gold is closer to 400%!

Surely it would be more profitable for banks to release "gold mortgages"? Oh no, you see that would be illegal, and banks and mortgage providers wouldn't want to do anything that wasn't legal would they?

Yet gold is the mother of all investments – the cure-all hedge when it comes to financial protection.

Are you suggesting that gold is the place to be?

Not at all. Gold is simply being used for illustrative purposes – and I won't go into the dangers and perils of gold investment here, I have spent far too much time on that in the past!

Property investment in the UK now is in a situation it has not seen before. The market has effectively been fed to itself and is now choking on it's own success – success only granted by debt availability which has been sold along the same lines as which a con-man sells his grandmother.

Ok, so no gold, and property is in a right old pickle – what now?

The property market has a few chances, but these chances only exist under certain criteria, and are dependant on what you are buying a property for.

If you are a first-time buyer:

Undoubtedly you will have been saving hard for a deposit in a bid to get on the property ladder. House prices in general at the moment are still on the high side, although if you look hard enough you will find the odd bargain. Having said that – if you are taking out a mortgage, this is where the impending peril starts. Interest rates will have to rise soon. Maybe not today, maybe not tomorrow, but soon. When they do, it will be a very tough time indeed. You may well be able to afford repayments based upon today's shiny mortgage rates – but 6 or 12 months time will be a very different story.

If you are going to Buy to Let:

The press, banks and mortgage providers are insistent that Buy to Let is the housing market saviour – not because they actually believe it, but because the government has told them it is by changing Stamp Duty and opening up REITs to residential property. The idea behind all of this was to keep the masses happy by attempting to stimulate investment into the sector from the institutions and keep house prices level to stop public revolt. To a degree, similar pitfalls apply to this sector as to the first-time buyer. Mortgage and interest rates will rise and make the investment unviable very quickly for one very simple reason – wages. Unemployment is on the up, pay cuts are rife and Joe Public can only afford rent up to a certain point, beyond which the market becomes unsustainable and no longer profitable.

Whilst there are still some risks surrounding the property market as far as prices rising or falling, the fluctuation in values is not much different to any other time in the past. The difference and dangers now are not the property at all, the danger is the credit used when buying.

As long as the banks are allowed to keep thinking for themselves creating mortgage products purely based upon getting fees in the door, you, the punter, are going to get burnt. The banks cannot help themselves when it comes to self-prophesising doom under the guise of press releases. Mortgage products are created by banks to suit their balance sheets, not your affordability. Yes, first time buyers need help – I don't doubt that - but they don't need help in the form of negative equity, escalating debt, and an inability to pay for what they have borrowed.

The only way the property market holds any profit in it at the moment is as follows:

  • Buying for the long term – 10 years plus.
  • Buying total wrecks and redeveloping them (this too is not without its perils for a whole herd of other reasons).
  • Buying in cash, or at least a very low ltv mortgage (and not checking average prices every 5 minutes and moaning about it).
  • Buying into property through another investment vehicle. REITs, PIFs, PINs and funds, any property investment vehicle that does not involve you borrowing money to do so – and is not reliant upon the credit markets to be successful.
  • Buy property outside the UK.

Fixed rate mortgages while rates are low might sound great, but if you can only just about afford it now...

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