With many families sweating for fear of further impending interest rate rises, there are signs in the housing market that those movements may have peaked. Sam Barrett reports
The fortunes of the property market are extremely important for the protection market. With as much as 70% of protection sales linked to mortgages, a downturn in the market will have serious ramifications for the protection industry.
Certainly, there are signs that things could be about to change for the worse. The Bank of England Monetary Policy Committee has taken steps to take some of the heat out of the market. In the last year, there were five interest rate rises, taking the base rate from 4.50% to 5.75% at the beginning of July.
Stephen Smith, director of housing at Legal & General, believes rates have probably peaked now, although there is potentially room for another 0.25% rise. "The minutes from the June meeting showed there was a split vote on the decision to increase rates, so we could have reached a peak," he explains, adding that the effect of a rate rise can take many months to affect the housing market. "Raising interest rates used to be a way for the Government to take money straight out of the public's pocket, but, now, with more than 70% of homeowners on fixed-rate mortgages and many variable rates reset annually, the increase isn't felt for some time," he explains.
For example, the last cycle of interest rate rises was in 2004 when rates rose from 3.75% to 4.75%. This took a year to trickle down to the housing market, with approvals falling off in 2005.
Aftershock
Assessing the pattern of fixed-rate deal approvals, Smith believes the financial pain could be felt sooner rather than later. "There was a huge boom in two-year fixed deals four years ago. These remortgaged in 2005 and will be set for another deal this year. They're facing a fairly significant increase so we'll wait to see how this affects the market," he adds.
But, while homeowners are still to feel the effect of the increased cost of mortgages, there has been a slowdown in property price inflation, suggesting the boom may be over. After the double-digit annual growth of the last decade, economists are predicting much lower levels of price growth.
The latest house price index figures from Nationwide show an increase of just 0.1% in July. This is the lowest level of increase since April 2006 and reduces the annual growth to 9.9%. Halifax is also going low, predicting a 6% house price rise over 2007 - admittedly an increase from the 4% it was predicting at the beginning of the year.
Further, the Royal Institute of Chartered Surveyors (RICS) is predicting growth over the year to be 7%. Oliver Gilmartin, senior economist at RICS, believes that the market is only beginning to see signs of the slowdown. "The first signs are there but we're expecting the slowdown to be more marked around Christmas and into Q1 of 2008."
This is supported by figures from the Council of Mortgage Lenders. In June 2007, it reported its highest mortgage lending figures ever, up to £34.2bn from £31.4bn the previous month. However, in line with fears of a slowdown, the monthly increase was lower than previous years, standing at 9% compared with 12% in 2006 and 15% in 2005.
But, while most people are expecting a slowdown, few predict that the market is heading for a crash, pointing to several economic factors to support their claims. "Interest rate rises aren't sufficient on their own to cause a crash," says Smith. "You need additional economic bad news."
For example, in the 1990s when the market bombed, rising unemployment forced sales with repossessions, falling prices and negative equity ensuing. Likewise, in 2005 the economy slowed sharply and consumer confidence eased, taking the housing market with it.
Today, the situation is very different. Unemployment levels are very low and there is an influx of immigrant workers helping to buoy the economy. Furthermore, GDP growth is close to the long-term average pace, which means economic conditions are good and stable and will help to underpin modest growth.
Investors
Another factor that needs to be taken into consideration when assessing the housing market is the buy-to-let market. This has grown substantially since 1999, with everyone from the large landlords to private individuals looking to build an alternative pension pot getting involved.
According to the Council of Mortgage Lenders, there were 73,200 buy-to-let mortgages in 1999. By 2006 the number had risen to a staggering 849,900.
The popularity of this means of building wealth could be affected by the interest rate rises though. Bruce Collins, group compliance manager at Beacon Home Loans, explains: "A lot of people have been dabbling in the buy-to-let market and, while the bigger players will have large enough property portfolios to cope with the interest rate rises, the smaller players may struggle to make a profit."
This could result in a flood of rental properties coming onto the market. This could cause supply to exceed demand and force prices down. On the other hand, these extra properties may be swallowed up by the larger players or may actually help to support the housing market by giving first-time buyers more affordable stock.
Additionally, although rental income has been squeezed in the last few years and will tighten further as the interest rate rise is felt, demand will continue to be strong, especially with more and more people coming to the UK from Europe. "We have a gross under-resource of property in the UK," says Kevin Carr, head of protection strategy at LifeSearch. "Two million workers have come to the UK in recent years and they need to live somewhere. The Government also has ambitious house building plans to support demand."
While this demand continues, Gilmartin says that, even with the market slowing and rates higher, buy-to-let remains an attractive investment option. "If you make 4% a year on a £200,000 house this is equal to an £8,000-a-year profit," he says. "Because you only need to put down a 10% deposit, this represents an £8,000 return on £20,000, which is very attractive."
He adds that many of the more seasoned buy-to-let investors will be in a reasonably comfortable position whatever happens to interest rates. "Buy-to-let investors will have built up a large cushion of equity in their properties over the years. It will be harder for novice investors but this equity will prevent forced sales," he says.
But, even though everyone thinks conditions will prevent a crash in the housing market, a significant change in fortunes is expected with the protection market having to adjust accordingly. For example, Carr expects prices to remain fairly flat for five to 10 years. "There'll be a levelling out, some will rise, some fall but prices won't really change very much for five to 10 years while society catches up in terms of salaries. The last 10 years have been mad," he adds.
In the longer term, this will be beneficial for the market. As the gap between earnings and house prices narrows, it will be easier for first-time buyers to get onto the property ladder, fuelling both the mortgage and protection markets.
But, until the market reaches this point, there may be some pain for the protection industry. "If fewer people are taking out mortgages then new sales of protection will be affected," says Carr.
Affordability
Although the interest rate rises are unlikely to result in a downturn in the housing market, they will affect affordability for anyone with a mortgage. "As affordability reduces, people start to make cuts in their expenditure," says Collins. "Hit with a £200 to £300 monthly increase when they come to remortgage, people will reassess their outgoings. Unfortunately, protection is one of the first things to go, although this may depend on how well it has been sold."
And, while some people will simply cancel all their protection policies, Collins believes that some may make choices, whether existing customers or taking cover out for the first time. "Many people regard life as a 'must-have' alongside a mortgage, with critical illness (CI) seen as a 'like-to-have' that will be dropped first," he explains. "For new mortgages, it'll be a lot easier to secure a £10 a month life assurance premium than a £60 a month CI one."
But, there are no indications of these cancellations coming through just yet though. For instance, Carr says he has not seen an increase in the number of cancellations on protection over the year. "It may take a while before we do see this because fixed-rate mortgage deals delay the impact of the interest rate rises," he adds.
The quality of the sale remains an overriding factor and Smith is keen to emphasise the opportunities for advisers to boost sales when clients are remortgaging. "People are never as open and frank about their finances as when they're talking about their mortgage," he says. "This is an ideal time to promote protection products as well as protecting revenue streams that may be affected by the slowdown in the housing market."
Sam Barrett is a freelance journalist
