UK faces £459bn housing crash

The far-reaching consequences  would include a spate of bankruptcies and repossessions as home owners, mortgaged to the hilt, suddenly found their biggest asset falling in value.

Thousands more would face the agonising uncertainty of negative equity, where the value of their house falls below the outstanding mortgage.

Many experts accept that a  crash is not a matter of “if”, but “when”.

Despite a continuing rise in prices in the first quarter of 2007, they warn that a downturn could be only months away and that 2008 could see the 12-year boom come to an end with a “correction” at least as severe as the last crash 18 years ago, when prices plummeted by 15 per cent heralding a recession from which it took the country five years to recover.

The consequences today could be even more damaging, with record levels of mortgage and unsecured debt and a small army of speculators and buy-to-let enthusiasts making the market even more unpredictable.

The warnings make grim reading for Gordon Brown, whose likely tenure as Prime Minister would coincide with the crash. Many blame the Chancellor  for squeezing home owners with higher taxes, and particularly his reluctance to raise stamp duty thresholds in line with house price inflation.

Experts and financial institutions are coming to the view that prevailing economic circumstances are ripe for a crash.

The cost of property relative to people’s incomes is at a record high, reducing the supply of buyers. Interest rates have risen three times since last autumn with more increases likely, while unemployment is also rising.

Increases in the cost of gas and electricity have reduced the disposable income people need to service mortgage repayments and record levels of unsecured debt are starting to take effect.

In mid-1991, UK home owners owed £308billion to mortgage lenders. This has more than tripled to £1,025billion, a rise of 8.5 per cent a year.

In July 1993, unsecured debt totalled £52.5billion. It now stands at £212 billion, an average rise of 11 per cent a year. Yet average earnings have climbed by just 4.2 per cent a year since 1997.

A “wild card” factor will be the introduction of home sellers’ reports, due from June 1. Analysts worry that the cost and bureaucracy involved will discourage sales and depress the market.

The Council for Mortgage Lenders has admitted that their introduction will make the market more volatile.

While experts broadly agree with predictions by leading building societies and estate agents that modest rises will continue in 2007, a number are warning that next year could see the beginning of a downward spiral.

The last crash, between 1989 and 1994, saw property values dive by 15 per cent on face value and up to 40 per cent once inflation was taken into account. The result was thousands of repossessions and many home owners suffering negative equity.

If that were repeated, it would wipe at least £30,000 off the value of the average £195,000 house and £450billion off the value of Britain’s 14.62 million owner-occupied homes.

Analysts are concerned that the UK could be at the mercy of international financial forces beyond its control. The most worrying of these is the crisis  engulfing the property market in the United States where sales of new homes fell 3.9 per cent to a seven-year low in February, following a 15.8 per cent drop in January. The glut of unsold homes has risen to 8.1 per cent, the worst figure since 1990.

Americans, like their British counterparts, had been relying on the housing market to fund their debt-fuelled spending and analysts fear that a housing crash will trigger a recession there which will be felt around the world.

An indication of the concern in the financial world comes from the Financial Services Authority,   which has ordered banks to assess how they would cope in the event of house prices crashing by 40 per cent.

The financial watchdog said that property prices falling by that much was an “appropriate” estimate, as was the figure of 35 per cent of mortgages in default and ending with homes being repossessed.

David Miles, chief UK economist at the investment bank Morgan Stanley warned that only half the recent growth in the housing market could be explained by demand and supply. The rest was due to a speculative bubble that could be about to burst.

Mr Miles, who led a government investigation into the mortgage market two years ago, warned that speculative property investors, particularly in the buy-to-let market, have fuelled much of the latest boom. This has led to unrealistic expectations about house prices that have fuelled further inflation.

He warned: “A substantial fall in real house prices is likely at some point in the near future, though it could be one to two years away.”

An index of housing affordability which compares house prices and mortgage costs with incomes has plunged by seven per cent over the past 12 months and property is at the lowest level of affordability since 1991.

Diana Choyleva of Lombard Street Research says rising interest rates will be the final straw for the property boom.

She said: “We think there will be a correction next year, although it is unlikely to be as severe as the last crash.

“The Bank of England may have little choice but to raise interest rates further and 2008 could be a difficult year for the UK housing market.”

Professor David Smith of the University of Derby said the Bank would have to raise interest rates more sharply than expected this year, leading to a slowing of house price inflation and a downturn in 2008 or 2009.

The investment bank ABN Amro warned that UK homes were 50 per cent over-valued, making the market even more vulnerable than in the US. It blamed much of the problem on property speculation. Evidence that the UK was following the US into a property crisis came from the credit rating agency Standard & Poor’s which warned that signs of stress were emerging in the British sub-prime industry, which specialises in lending to borrowers with patchy credit histories who cannot get mortgages from traditional lenders.

The US sub-prime market has collapsed as falling house prices have created billions of dollars of bad loans.

Almost a quarter of loans to the British sub-prime sector are 30 or more days in arrears while re-possessions have tripled since the end of 2004. Sub-prime mortgages accounted for ten per cent of all new advances in the UK last year – about £30billion.

Some experts argue that if property inflation balloons and the bubble bursts the fallout will be more damaging than if the market cools more gradually.

Others warn that an already fragile market could collapse if interest rates go up again.

The Halifax’s group economist, Tim Crawford, said: “Prices continue to rise in a tight market but there are emerging signs that pressure on householders’ finances, partly due to the rise in interest rates since last summer, are dampening demand.

“We expect the recent rises in interest rates, negative real earnings growth and above-inflation council tax bill increases to lead to slower house price growth over the coming months. Sound economic fundamentals and an ongoing shortage of supply will, however, continue to support house prices.

●Additional reporting by Emily Garnham