The mortgage gap

  • Robert Peston
  • 24 May 08, 07:00 AM

The cost of mortgages for many of us is probably still on a rising trend.

Here's why.

Net lending for mortgages - that's mortgage lending over and above the refinancing of existing mortgages - was £110bn last year (it was a similar amount in 2006 and a touch less in 2005).

According to a leading bank, net lending this year will be £60bn.

For sale signsNow you may be surprised that net lending - which represents an increase in the stock of UK mortgages - isn't nil at the moment, given that there's been a sharp drop in the number of housing transactions and house prices are moving downwards.

However, a zero increase in net lending would be associated with a housing market in total freefall - because most people only move house every few years, so the sharp rise in house prices over five years or so guarantees a rise in the value of net mortgage lending, even as the number of transactions falls.

But although the market isn't in freefall, a drop from £110bn to £60bn - a 45% decline - is pretty substantial and significant.

Let's look at why it's happened and then what it means.

It reflects two factors:

1) the nervousness of potential buyers about whether they should postpone purchases till house prices have fallen a bit more;

2) a massive shrinkage in the lending capacity of banks and building societies.

The second cause is the more important.

HBOSAs I've written and broadcast recently, mortgage lending is currently dominated by just a handful of our biggest banks led by HBOS.

Specialist mortgage lenders have vanished with the closure of the mortgage-backed securities market. Small building societies are barely lending a thing. And medium size banks have cut back their mortgage-lending very significantly.

Even the biggest building society, Nationwide - which announced impressive financial results recently - is reducing net lending.

So competitive pressures on mortgage rates have all-but vanished.

The reason - natch - is the notorious crunch of credit, banks' inability to raise substantial sums of long-term finance at a reasonable price on wholesale markets.

And although the Bank of England is providing valuable funds to the banks by allowing them to swap mortgage-backed securities for highly liquid government paper (cash, to all intents and purposes), this is only enough - by explicit design of the scheme - to allow the banks to finance their existing commitments, not to make incremental loans.

Bank of EnglandAlso, the £100bn odd of succour being provided by the Bank of England is not cheap money - but that's a story for another day (as is the longevity of this government-backed financial support - with the Bank of England, as I understand it, likely to hold these mortgage assets for at least four years, far longer than was widely thought).

But let's get back to that £60bn of net mortgage lending that'll be provided this year.

It may sound like a lot of money, but it compares with an estimated £80bn to £85bn that house buyers are expected to want to borrow.

That £85bn-ish is derived from estimates of those who have to move house for various reasons or are desperate to buy their first home.

So to put it another way, the supply of net additional mortgage money is currently around 30% less than demand.

Which means that a staggering number of wannabe borrowers - such as those that can't afford the deposit - are being turned down by banks and building societies.

By the way, those unable to buy a house or move home - and the £25bn funding gap suggest there could be well over 100,000 who can't raise the wonga - are unlikely to be rallying to the cause of Gordon Brown, at this, his moment of some need.

There is a further painful consequence of this mortgage shortage for existing and potential homeowners. It's that mortgage interest rates will be under significant upward pressure, almost whatever happens to money-market interest rates or the Bank of England's base lending rate (which isn't likely to be cut for some considerable time, if at all, in any case).

In fact the few banks still participating in the mortgage market in any size tell me they are planning - in as quiet a way as they can - to nudge up their rates in the coming few months.

The reason is a law as old as commerce itself, the law of supply and demand. For the first time in years, there is massively more demand for mortgages than supply.

Is it remotely realistic in those circumstances to expect that the big banks would not raise prices to take advantage of all that pent-up demand?

Are they charities?

Apart from anything else, the risk of providing mortgages has risen.

The economy is slowing down, increasing the incidence of default. And house prices are falling, eroding the value of collateral.

Banks are - understandably - keen to be compensated for the increased risk of financing house purchases in an economic climate that is a lot less benign than it was.

The mortgage market will therefore remain tight and expensive for some time.

Which will exert downward pressure on house prices - not colossal downward pressure but unremitting.

And a second source of negative momentum on house prices is the demand by all banks for bigger deposits from borrowers, which - as I have explained before - acts as powerful gravity bringing house prices down to earth.

How long could the downward trend in house prices endure? Well one leading bank is bracing itself for a "correction" lasting two years.

That's how long there is to run before the next election. So Gordon Brown and the Labour Party can't assume the feel-good factor will be back in the nick of time for them.

Branch of Northern RockI also can't help but wonder how on earth Northern Rock can run down its mortgage book to repay that £25bn odd of taxpayer-funded loans on the tight schedule it has promised.

It needs to persuade its borrowers to refinance their loans with other banks - but, as I've pointed out, there's a chronic shortage of lending capacity elsewhere.

Northern Rock may be stuck with more borrowers paying expensive variable rates of interest, as they come off the cheap fixed-rate deals, than it would want - though they're profitable customers, for as long as they can afford to keep up the steep payments.

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