This article was first sent to Fools as part our Afternoon email campaign.
For property ownership to flourish, we need three things: willing buyers, affordable prices, and access to reasonably priced credit.
Of course, during the housing and credit booms of 1996 to 2007, there were millions of keen buyers and investors, plus we were awash with cheap, easy credit. Hence, the property market boomed, with prices rising uninterrupted for twelve years in a row, including an astonishing jump of more than a quarter (25.8%) in 2002.
Then something nasty happened
Last year, the property winning-streak came to an end as bankers' chickens came home to roost. It became clear that banks had been lending to anyone who could sign their name. The massive losses caused by this reckless lending blew up vast amounts of the banks' capital, leaving them short of cash. This led to the now-familiar `credit crunch' -- the simple inability of banks to raise enough money from savers or wholesale markets to lend to eager borrowers.
Thanks to the credit crunch, mortgage availability dried up, causing house prices to dive. Indeed, in 2008, prices fell by almost a fifth (18.9%), according to the Halifax House Price Index. However, in response to the worsening economic climate, the Bank of England has slashed its base rate from 5% to 1.5%, with further cuts expected. This brings down the cost of credit for most borrowers, except those with fixed-rate loans or mortgages.
So, house prices have come down, plus the cost of servicing a mortgage has fallen, both of which help people to climb the housing ladder. Thus, things must be looking up for the housing market in 2009, right?
Wrong. Banks are rightly terrified of losing money on current and future lending. Hence, there are no more 125% or 130% `negative equity' mortgages, and what mortgage finance is available is being reserved for the lowest-risk borrowers.
The mortgage famine persists
According to an industry survey earlier this week, the number of different residential mortgages on offer has dropped to 4,357. In December 2007, this figure was almost ten times higher, at 40,910. Indeed, the current figure is as low as it was in February 2002, almost seven years ago. So, all `Wild West-style' mortgages have disappeared. In their place are home loans with much tougher entry requirements.
Of course, fewer products lead to greater demand for those remaining. This problem is most acute for first-time buyers and movers without a large deposit or plenty of equity in their existing home. In fact, borrowers without a 20% deposit have fewer than two hundred different mortgages from which to choose.
Even worse, if you have managed to save only a 5% deposit -- say, £7,500 on a £150,000 property -- then only one lender is interested in lending to you. Ipswich BS will lend to these `marginal' borrowers, but only if they have been a member of the Society for six months. Given Ipswich BS's local focus, this pretty much rules out applicants from outside East Anglia.
With a deposit of 10% of the purchase price, you need a 90% loan-to-value (LTV) mortgage. A further ten lenders are willing to lend to borrowers in these circumstances. Among these is the Royal Bank of Scotland, recently bailed out to the tune of £20 billion by taxpayers, who now own around three-fifths (60%) of the fallen Scottish giant.
Sadly, with yearly interest rates ranging from 4.99% to 6.64%, these low-deposit loans are far more expensive than those on offer to the safest borrowers. For example, if you have a 20% deposit, then First Direct is willing to lend at 3.39% a year. Also, HSBC has just launched a 75% LTV mortgage at its lowest-ever rate of 2.99% a year (but only for its Premier banking customers). These huge `rate gaps' clearly show that, at last, banks are properly aligning their rates to suit individual risks.
Now for the really bad news
Academic research in the US has shown that the health of the housing market depends on the easy availability of no-deposit and low-deposit home loans. Without these, it's a fingertip stretch on tiptoes to the first rung -- a gap prevents some potential homeowners from getting on the property ladder. Indeed, the housing market resembles a Ponzi scheme which, without a constant supply of fresh blood, is sure to stumble.
So, expect more house-price drops until lending returns to `normal' again -- and by this, I mean the levels of the late Nineties, and not our millennial mortgage madness!
More: Try our first-class mortgage service | The Truth About The Credit Crunch | How The Base Rate Affects Your Mortgage