With the recent problems in the banking sector, many of us are wondering what will happen next in the property market. Mortgage adviser Lawrence Garry looks at what’s been happening.
There has been much speculation about the health of the property market following the recent ‘credit crunch’ which seriously exposed failings of elements of the banking system. Northern Rock has not recovered from the queues of customers who picketed branches to withdraw their savings and threw the financial stability of the bank into question in the process.
Homeowners and investors are understandably concerned about the broader impact this will have on the UK finance and housing market.
What is the credit crunch? The credit crunch was caused by a liquidity crisis in the financial market. In short because of high repossessions in the US the value of the mortgage portfolios that the banks were selling lost their worth, which reduced their profitability and the banks’ liquidity.
Investment banks usually sell interests in a pool of mortgages. The value of the package is worked out from the expected future cash flow from the mortgages that make up the pool. When these pools were packaged together a certain percentage of the mortgages were expected to default and end up being repossessed. However, what happened was that the defaults and repossession rates were higher than expected.
The main problem with this scenario is that some of the mortgages should never have been made in the first place. Lenders who were desperate for new borrowers were willing to make risky loans in the sub-prime market for greater returns and this backfired.
What caused the problem? The credit crunch was caused by huge losses made by banks that provided mortgages to sub-prime candidates with less than perfect credit records or low incomes. They defaulted on their mortgages and their homes were repossessed. The banks had to write off their loans and as a result made huge losses in the process which drastically reduced their profitability and liquidity.
Why has this affected the UK? My understanding is that this has affected the UK banks because some of them are backed by US lenders and others have bought these sub-prime loans, often packaged up in pools of debt called collateralised debt obligations which lost their value.
How will this affect my mortgage?These problems are unique to a handful of lenders and particular those who specialise in sub-prime lending. It may mean it is more difficult to obtain credit if you are considered a sub-prime applicant as some lenders are introducing tougher criteria to reduce their exposure. For traditional borrowers the effects should be limited – and in any case the situation should gradually return to normal.
Lawrence Garry is a property investor and a director of mortgage adviser Milestone Financial Services. Submit your property market questions to lawrence.garry@milestonefs, call 020 7719 0170 or visit milestonefs.com