Tag Archives | house prices

Does the UK have a housing bubble?

Readers Question: Do you think the help to buy scheme is fuelling a housing bubble? Only about 3% of houses are bought through this method but do you think that it is likely that a bubble will develop?

In a way, I think you answer the question yourself in stating that only 3% of houses are bought through this method

With such a small percentage of homes bought through this scheme, it is not going to be a major cause of a housing bubble; however, in a relatively significant way, it will add to housing demand. Given the inelastic nature of housing supply, it will make a contribution to pushing up house prices.

Without the help to buy scheme would people have bought houses anyway? I’m not sure. I think the scheme will definitely help some to get a mortgage, and therefore buy rather than renting. In that regard it is adding to housing demand, and therefore pushing up prices, but only a small amount.

Will a housing bubble develop?

This is a more difficult question. There are different types of housing bubbles.

One is the housing bubble experienced by US, Ireland and Spain – where property prices rose substantially above average earnings, and then fell by up to 50%. This is because house prices in these countries became divorced from the fundamentals of housing supply and demand. When the mortgage market experienced difficulties, demand fell and prices fell significantly. The crucial thing about US, Ireland and Spain was that after the housing bubble and bust, there was a large excess supply of housing. Therefore, when demand fell, prices fell considerably.


See: Ireland Housing bubble and bust

The UK housing market behaved differently. When demand fell in 2007/08 because of the credit crunch, prices did drop by 20%. But, house prices stabilised much quicker, and then – defying many predictions – began to rise quite rapidly. Meaning that in the UK, house prices in many areas are higher than before the crash.

The main difference is that in the UK, there was no excess supply of housing; there was no boom in home building. Therefore, when the crash came, there was still this fundamental shortage of housing, which keeps prices ‘artificially’ high.

Why UK property prices may be overpriced


  • Interest rates set to rise. UK interest rates have stayed at zero since early 2009; this period of ultra low interest rates has benefited the property market and kept mortgages affordable. If interest rates rise back to ‘normal’ rates (e.g. around 5% – many homeowners will see a sharp rise in the cost of mortgages, causing demand to fall. The Bank of England recently did a survey and found a two-percentage-point rise in mortgage interest rates would likely raise the proportion of mortgagors with a debt service ratio (DSR) of at least 40% from its current level of 4% to about 6% (360,000 to 480,000 households)


    UK housing – prices kept affordable by low interest rates.

  • House price to income ratios. House prices have risen much faster than incomes, meaning the younger generation are not able to get a mortgage. The average age of mortgage holders has increased, and the deposit required has also gone up. Because house prices are so expensive, there are many who cannot consider buying.

    House price to earning ratios for first time buyers. The ratio is 5.0 significantly higher than previous decades.

  • Buy to let market. With home ownership rates falling, the growth in demand for housing is coming from investors.


    These investors are more likely to be sensitive to changing house prices. If there is a sustained drop in prices, this may be magnified by investors leaving the UK housing market.

  • Economic growth is still fragile. Although the UK recovery is reasonably strong, the Eurozone looks weak with anaemic growth and the threat of deflation; there is a strong possibility that a weak EU economy could act as a drag on UK growth.

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House prices and interest rates

There is concern that UK house prices are rising at an unsustainable rate. In the past 40 years, UK house prices have consistently grown faster than average earnings. (Why are UK house prices so expensive)


Even as the economy just begins to emerge from recession, the housing market is already showing signs of overheating. In some areas, house prices are rising 10%  a year – much higher than CPI inflation of 1.6%.

Expensive house prices threaten the economy in various ways:

  • Make many areas unaffordable for young people causing shortages of skilled labour.
  • Increased wealth inequality between home owners and renters.
  • An unsustainable boom in house prices could lead to an eventual fall in prices, with corresponding bank losses and negative wealth effect.
  • See also: Problems of expensive house prices

How do interest rates affect house prices?


Interest rates were cut in 2008/09 – causing a a decline in the cost of mortgage payments

  • Currently, in the UK interest rates are very low. Base rates, set by the Bank of England, are currently 0.5%. This has reduced the cost of mortgage payments, making buying a house relatively attractive.
  • It means that despite the rise in house prices, mortgage payments are not too expensive. With interest rates so low, it make sense to try and buy. This increase in demand for housing is one significant factor in pushing up prices.

The effect of rising interest rates on the housing market

  • If interest rates rise it will have a significant effect on increasing the cost of mortgages. This will deter prospective home-buyers, but it may also force some existing home-buyers to sell. The danger is that many homeowners are being protected by ultra low interest rates. If rates rise, this will make mortgage payments too expensive and they may be forced to sell.
    • This increase in sellers and decline in buyers will cause house prices to fall.

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UK House Price to income ratio and affordability

An examination of UK house price affordability.

In 2013, UK house prices rose 8%, and most forecasters expect UK house prices to continue to rise above inflation in the short term. However, there is a big concern that house prices are already unaffordable for most first time buyers. In many parts of the country, potential buyers are being kept out of the market due to house prices being much  higher than average incomes. Because of the lack of affordable housing, many have criticised the government’s Right to Buy scheme – which concentrates on helping people get a bigger mortgage rather than deal with disequilibrium of supply and demand.

UK nominal house prices since 2002


Mortgage payments as % of income

One useful measure of housing affordability is to look at  mortgage payments as a percentage of income. In this regard, it doesn’t look too bad.


ONS house price index Nov, 2013

Since interest rates were cut in 2009, mortgage payments have fallen to a near 20 year low of just 16% of income.

  • However, when interest rates rise, many homeowners will see a nasty shock of rapidly rising mortgage payments.
  • Also, rising house prices have required a bigger deposit. This means many who might be able to afford mortgage payments are unable to get a mortgage in the first place

Deposits required for first time buyers


The deposit required has risen particularly for first time buyers. from 10% of purchase price in 1995 to 23% in 2012.

Ratio of house prices to income

Another way to examine the affordability of house prices is to look at the ratio of house prices to income.

This ignores the unusually low interest rates affecting cost of mortgage payments and gives an indication of long term trends.

ftb-house-pirce-earningsSource: Nationwide

Firstly, there is a big regional disparity. First time buyers in London are seeing house prices at a record 7.5 times average earnings. For the UK as a whole, the ratio of 4.3 is still above long term trends. It is a higher ratio than the end of the 1980s housing boom.

Mortgage payments as a % of take home pay for first time buyers

For first time buyers taking on large mortgages, the mortgage payments are still taking up a big % of take home pay – despite the low interest rates. The average mortgage payments is lower for average homeowners because many householders took out a mortgage when house prices were cheaper.

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Would a cap on house prices work?

Readers Question: Would a cap on house prices work?

Despite the recession and credit crunch, UK house prices continue to rise. (See: Why are UK house prices so high?) This has caused record levels of house price to income multiples. For homebuyers in London, house prices are approaching a record seven times average earnings. Understandably many feel house prices are already too expensive, and there is a strong case for trying to limit future house price increases.


For example, the Royal Institution of Chartered Surveyors have suggested that the Bank of England impose a cap of 5% a year on house price growth. (Independent link)

Firstly, how would a house price cap work?

The Bank of England cannot influence supply in the short term. Therefore, they would have to influence demand through credit controls (e.g. limiting amount of mortgages) and possibly interest rates. Both have drawbacks and limitations.

1. Interest Rates

In theory, The Bank of England could use interest rates as a tool to influence house prices. A rise in interest rates, in the current climate, would inevitably cause an end to the house price growth as mortgages would become more expensive. Mortgage payments are a large % of disposable income, therefore any change in interest rates will have a significant impact on reducing housing affordability and housing demand.

However, the use of interest rates to control house prices has significant drawbacks.

  1. The main aim of monetary policy is the control of inflation and economic growth. If the Bank is asked to also target house prices, it would mean the Bank of England are placed in a difficult position. To prevent house price rises in London, may require higher interest rates. But, at this stage in the economy cycle, a small increase in interest rates could sniff out the recovery. Interest rates can only achieve so much.
  2. Time lags. A change in interest rates will take time to feed through into the housing market. Ideally, the Bank of England would anticipate house price changes, but in practise this is difficult to do. Few would have predicted the strong rise in house prices in recent years. If the Bank did increase interest rates to affect demand for houses and mortgages, it could easily get it wrong. By, the time mortgage rates rose, house prices may be falling anyway.

2. Mortgage regulation

A more realistic option is for the Bank of England to adopt new regulation which makes mortgage lending scarcer. If house prices are rising too quickly, the Bank of England could introduce controls which limit the availability of mortgages. This could involve insisting on certain size of deposits or limiting the size of income multiples. Continue Reading →

Why are UK house prices so high?

In the past five years, we have had a devastating global credit crunch, the longest and deepest recession since the 1930s (if not worse). Across Europe, we have seen mass unemployment and in countries like Spain, Ireland and Portugal, the housing market has seen up to 50% falls in house prices. Yet, despite this financial and economic upheaval, UK house prices have bucked the trend and avoided a major collapse that many were predicting as the credit crunch hit.

It is true that in the first years of the credit crunch, UK house prices did fall 20%. But, the resilience of house prices in the past few years has been less expected – despite the ongoing weakness of the economy.

According to information from the Land Registry of England and Wales, the annual % change of UK house is nearly 7% (BBC house prices) The average house price is £242,415.

It is perhaps too early to start panicking about another housing bubble. But, what thing is undeniable – UK house prices are very expensive and are close to record levels compared to earnings.

Average selling house prices according to the Nationwide


According to the Nationwide, house prices are still below their 2007 peak, but are close to regaining former ‘bubble levels’


This graph shows that since the 1970s, house prices have risen significantly – even adjusted for inflation.

More worryingly, the ratio of house prices to income continues to remain above long term trends.


Source: ONS mortgage survey 2012

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Irish property market – boom and bust

During the 1990s and first half of 2000, Ireland had one of the longest property booms on record. Between 1996 and 2006, the average price of second homes rose in Ireland rose by over 300%. The average price of new houses rose by 250%, according to the Department of Environment, Heritage and Local Government (DoEHLG). However, since the peak in early 2007, Irish house prices have fallen 50% – and there are few signs of promise for the Irish housing market.

The rapid rise in Irish prices was initially a reflection of economic fundamentals.

  • Economic growth enabling more people to be able to afford to buy.
  • Irish house prices were relatively cheap in the early 1990s.

However, from the early 2000s, house prices increasingly reflected a boom period, with prices pushed higher by:

  • Speculation, with property developers buying to let.
  • Expectations of continued rising house prices encouraging people to get into property.
  • Rising house prices encouraged home owners to take out equity withdrawal and use the money to invest in second homes.
  • A booming and unregulated banking sector. The finance boom encouraged banks to lend more variable mortgages with lower deposit requirements – 100% mortgages were common. Also people borrowed very high salary multiplers. Mortgages upto 10 times salary were said to be given.

Irish vs UK house prices


Both property markets see a sharp fall in house prices in 2008/09. But, whereas the UK property market stabilised, Ireland continued to see one of the longest continued periods of falling house prices – making it one of the biggest global property collapses.

The Irish housing market crash


Source: CSO

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