Falling house prices leave borrowers marooned

Cast your minds back to 1992 if you can. To give you a helping hand we can remind you that on TV you were enjoying Absolutely Fabulous for the first time, you probably weren’t enjoying the short lived soap Eldorado, and a young ginger haired man named Chris Evans got a job presenting the Big Breakfast.

Musically, Vanilla Ice was the main man with Ice, Ice baby and the queen was having an annus horibillis. President Clinton was also elected but we’re not sure that was linked.

Another thing that you may remember if you are the wrong side of 35 is Negative Equity, and just as everything ‘retro’ is now back in vogue, so it is also.

For the young, uneducated, or both, negative equity is where you owe more on your mortgage than your property is actually worth. This causes several problems, mainly that you cannot sell your home, because it will not realise enough to repay the mortgage.

Those that took 125% mortgages with Northern Rock over the last few years were immediately plunged into negative equity although house prices were rising so fast at the time, that this was only temporary. The unthinkable has now happened and house prices have been dropping for some time, meaning that even people who took 90% mortgages are also now in Negative Equity.

There is still a general feeling of denial amongst the British public about property prices, but the simple fact is that mortgage valuers are working on 2005 values.

Some people may argue that it doesn’t really matter as long as you don’t sell your home and they would be right. Your home never was and never will be an investment as such. It is a functional asset that may change in value over the years but it is not an investment that you can cash in whenever you like and spend the proceeds on something else.

There is another problem however, which we have labelled as ‘mortgage marooning’. Interest rates are at a historic low but mortgage rates have become so detached from the Bank of England rate that it doesn’t really matter anymore. Average fixed rates are between 4% for up to 60% loan to value, and 7% if you need a 90% deal, neither of which are particularly bad when viewed in the long term context of interest rates.

So at the moment you have a choice, you can get a nice 5-year fixed rate for around 5% and enjoy some protection from the upcoming storm. Or if you feel pretty confident, you can remain on a reasonably low standard variable rate and then jump onto a fixed rate if interest rates start to rise.

The problem occurs if you need to borrow more than 90% of your property value because to be blunt, you can’t. In fact there are only five lenders who will actually lend between 85% and 90%. So if you are coming out of a fixed rate now, with a loan to value of more than 90% then you have no option other than to take the lenders standard variable rate. This shouldn’t be too painful at the moment but there is something else that needs to be considered.

It is probably the worst kept secret in the world that interest rates are going to go up in the next year or so, but what will happen when they do? If the lenders margin on mortgage rates remains at around 4% then assuming the Bank of England rate rises to a modest 5%, then mortgage rates would be 9.5% and that would be a lot of pain for a lot of borrowers. Furthermore, if you are in negative equity then you can’t change your mortgage rate to a lower or fixed rate because no one will lend to you, and you can’t sell your house because it is worth less than your mortgage, so what do you do?

Well in 1992 what happened was that people walked into their banks and handed back the keys to their property. The banks then went and sold your home at auction for a fraction of its value and chased you for the difference.

A favourite trick of the bank is not to chase you straight away, as they know you have no money to pay, so they wait five years until you get yourself back on your feet. Then they come after you for the money you owe, plus a rather hefty rate of interest in the meantime. In fact some people are still being chased now for debts in the 1990’s.

So think very carefully about what rates are on offer if you have a high loan to value, and your property value is still falling. That long term fixed rate that you don’t take now, may look very appetizing in a year or two if you are looking down on it from 10% meaning you could be having your very own annus horribilis. It could be worse mind; Vanilla Ice could make a comeback….

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