UK mortgages: financial innovation run amok. Source: Google images.
In a never-ending saga, I’ve spent quite a lot of free time these past few weeks studying the UK mortgage market. In sum: crazy:
- Where I’m coming from: US mortgages. In particular, the fixed-rate 30-year mortgage guaranteed by Fannie Mae or Freddie Mac. When my wife and I bought a house in the US, the choices were pretty much either a 15-year or 30-year fixed rate mortgage. Simples.
- How about a 30-year fix in the UK? Nope, not available. If only Americans fully appreciated how sweet the government support of housing is in the US. No dice in the UK. BTW, for those wondering – mortgage interest is tax-deductible in the US, but not in the UK. But anyway.
- What do Britons do? Fix for 2 years. The standard mortgage here seems to be a 2-year fixed rate, which then reverts to a penal ‘Standard Variable Rate (SVR)’ charged by the bank. Given low rates, there are several offerings for 3-, 5- and 10-year fixes these days. In practice, the assumption is the mortgager refinances by the end of the fixed rate period – spending another £1,000 or so on fees for the privilege of keeping a discounted fixed rate. Or they move, or pay off the debt, or…
- How to take advantage of low rates? Variable/tracker mortgages. If you believe rates will continue to fall, there are mortgages which either reflect changes in that SVR (‘variable’) or changes in the Bank of England base rate (‘tracker’). Those smart cookies who successfully predicted the massive fall in BoE base rates entered a strange world of negative mortgage payments in 2008/9. With the base rate at 50bps, I’m guessing there isn’t much further to go.
- Extension: but what if I wanted to ‘fix’ my own 30-year mortgage? The SVR is completely at the discretion of the mortgagee – they can change at will, so very hard to hedge interest rate risk on a variable, or indeed 2-year fixed, mortgage. The tracker is more interesting – BoE interest rate decisions generally take place at meetings announced well in advance, so could in theory be hedged. I’m looking into solutions involving Short Sterling and/or UK gilt futures to achieve the fix.
- Brilliant UK innovation – offset mortgages. It’s well-known that paying off mortgage principal early is a good thing, to build equity and lower total interest paid. But what if you come across a load of cash (a bonus, perhaps), with a potential need for said cash in the future (early retirement, perhaps)? The offset mortgage allows your cash savings to offset the mortgage principal; you can still access your cash if needed, but otherwise you only pay interest on the net amount of principal outstanding. I like that feature, though it comes at the cost of higher interest expense.
- But wait – don’t you loathe the UK housing market? Hmm… yes, particularly in London area. Upon further research, housing in the Midlands and North of England (+ Scotland and N Ireland) isn’t as overpriced/undersupplied as the dreaded Southeast. This is reflected in gross rental yields: London yields are a joke (3% p.a. before fees/fixes? Happy to rent with that.), while yields elsewhere are much more reasonable. So maybe worth investigating a purchase further afield.
What fun, investigating financial products. Ah, to have a 3.8%, 30-year fixed mortgage with a tax credit to boot instead.
Where can I live on my median income? Source: londonrents.org.uk
I’ve written before about my confusion/frustration/anger at the UK housing market. This view was reinforced by a recent Dispatches episode (for US readers, think 60 Minutes). Now I could get very investigative about the issue myself – given I feel strongly about this issue, I may well in the future – but for now some thoughts from various readings/viewings/stats:
- There seems to be an obvious market failure going on in UK housing: lack of supply. The Dispatches episode quoted the need for about 240,000 new homes each year to meet basic housing formation, with only about 100,000 being built. The figures are the same for London, in terms of housing built as proportion required.
- Call this a lack of understanding, but even Enzo Ferrari knew that you only needed to produce 1 unit less than demand to ensure pricing power. This gap seems completely self-defeating for property developers. In economics 101 terms, surely the marginal revenue isn’t maximised at this level of production; producers could still improve their (surplus) profits by producing more units.
- Why aren’t developers producing? It’s probably a similar situation to cities like San Francisco/NYC, whereby geographic limits constrict supply. In London’s case, however, these limits are self-imposed: green belts keep the property available within reasonable commute contained. Planning permission is a big issue, as well – London is a pretty low-rise city, and though that adds to the city’s charm, it lowers the city’s residential capacity. Developers must play expensive games with planners to build more, which probably leads to more production of expensive, high-margin housing than higher-capacity housing.
- The influence of foreign investors. Look, not every foreigner buying property in London is money laundering. There are loads of folks seeing London for what it is: a supply-constricted market with lots of professionals making decent cash. What I wonder about is buy-to-let hurdle rates: with mortgage rates at all-time lows, I suppose folks can be happy with a rental yield of 4-5% net of management fees. That would set a cap on property prices, unless of course rents increase at a faster pace. But if the latter occurs, who’s going to rent? Most of London is already unaffordable.
- What about those on the ladder? A frequent topic of London conversation is ‘getting on the property ladder’…maybe escalator would be appropriate here. The idea is that one just needs to buy any property, get some gains, then flip into a bigger property. Hmm… so one just keeps doubling down in the property sector. For those trading up the ladder – be aware that both losses and gains are magnified. In any case, I can see how this ladder situation puts politicians in a very tight spot: their constituents probably couldn’t handle a correction in property prices, as mortgages get called in.
- How about property tax? The UK has a sort-of property tax, like the US: it’s called council tax. The main difference, to me, is that the latter caps out at a pretty low level; US property tax is generally a set % of assessed value, with no cap. Here’s an idea for the UK, which would probably be an easy redistribution from rich -> poor: take away the council tax cap.
- What about mortgage rates? All time lows – check. UK mortgages primarily variable rate – check. Affordability based upon these low rates – check. So look out when rates rise. Again a politically difficult situation – why would the BoE ever raise rates, as so many people would probably find housing unaffordable.
In sum: UK housing is a classic asset bubble, in my opinion. So much unproductive investment pouring into land values. The fact the ‘housing ladder’ is ubiquitous should be a red flag that folks buy property because it always goes up…very dangerous. And these inflated prices mean ordinary (middle class!) workers can no longer afford to live and work in London and elsewhere. If the UK believes in equality of opportunity (and I think we do), why do we let this transfer of wealth from the lower-paid (stuck renting) to higher-paid (buy-to-let, with homeowners sharing positive externality) happen? Seriously?
Housing: get it while it’s hot? Source: Google Images.
Today’s Bloomberg has an article about housing affordability in various US cities, with some harrowing statistics. Apparently an average Brooklyn residence would cost 98% of median income in mortgage payments (10% down payment; 30-year fixed mortgage).
So that got me wondering about London. A quick calculation, using the same methodology as RealtyTrac in the Bloomberg article:
- London median income: £23,800 p.a. Source: London Datastore
- London median house price: £322,000. Source: same as above
- Average mortgage payment: £1,770 per month. That’s a 90% LTV, 25-year 5.5% mortgage. Source: MoneySupermarket
- Therefore, mortgage payment as % of median income: 95%
- A median income couldn’t borrow that much: The same mortgage calculator limits borrowing to around £100,000 for the median income. Smart, seeing as 95% would be taken by the mortgage payments. I assume this would be the same as the US.
- UK doesn’t do truly fixed mortgages: The nice things about US mortgages are:
- Tax-deductibility of interest (at highest marginal rate)
- 30-year interest rate fix. Today’s rate is around 4% p.a. (Source: bankrate.com)
- Therefore: if UK mortgage rates went up (and let’s be honest: they’re unlikely to go down much from here), the median income would quickly be insufficient altogether.
In sum: I guess we already knew this. Housing is VERY unaffordable. I’m sticking with other options.
I was interested in this article by the Economist over the weekend. In the latest ‘WTF?’ moment I’ve had when reading the financial/economic news, various US Government agencies have evidently removed the more stringent requirements on what qualifies as a government-guaranteed mortgage. Remember the heady days of 2007 and before, when ‘stated income’ (a.k.a. ‘liar loans’) and < 5% deposit mortgages were the order of the day? Welcome back, I guess. In another ‘WTF’ moment, evidently banks no longer need to have ‘skin in the game’ for RMBS they’ve structured from Fannie/Freddie mortgages; they can go back to underwriting mortgages to whomever they please, confident Fannie/Freddie will guarantee the loans for structuring. Again, back to the fun times!
The only somewhat relieving factor this time around is the US Government’s explicit ownership of Fannie and Freddie. I mean, the Government/taxpayer were on the hook for the costs of mortgage blow-up in 2008; at least this time the taxpayer gets a 100% profit sweep. It just makes explicit what has been common knowledge for a VERY long time: US taxpayers like people owning homes so much, they’re willing to subsidise each other’s purchases through the tax system.