As safe as houses? Britain's home truths

In a turbulent week for mortgages and interest rates, <i>IoS</i> experts explain how the bubble burst and advise on avoiding the worst of the fallout. And ex-Chancellor Ken Clarke tells Personal Finance Editor Julian Knight how he can say 'I told you so'

Ken Clarke knows all about housing market crashes. He was Tory Chancellor at the fag end of the worst one since the war, when a record 105,000 homes a year were being repossessed and millions were in negative equity.

For the ebullient big-beast politician, who has run for the leadership of his party three times, the news from the Halifax last week that house prices fell 2.5 per cent in March had a ring of inevitability about it: "I have been saying that the economy is floating along on a sea of debt for the last couple of years. I am able to say I told you so: we have had an unsustainable rate of borrowing.

"Twice, in the late Eighties and now, we have had ridiculous housing market bubbles caused by overconfidence in home ownership combined with ridiculously cheap credit."

And what Mr Clarke calls "crazy credit" means there are potentially huge numbers of people weighed down by debt that they have little chance of repaying. In disturbing echoes of the early Nineties housing crash, the Council of Mortgage Lenders (CML) say repossessions will rise 50 per cent this year. Debt charities are being inundated by people crying out for help.

"Banks have gone in for ridiculous lending over the past few years, 100 per cent mortgages even 125 per cent mortgages, five times salary. There are those that argue house price inflation has been caused by undersupply of houses, and in some parts that is true, but the fastest growth is due to the availability of credit.

"The danger now is that we will see house prices collapse, as is happening in the United States. If this was to happen, people will feel less wealthy, they will stop spending in the shops and that will make the economic slow-down we are already experiencing, much more serious."

As a senior minister in the Thatcher and Major governments, Mr Clarke saw how Britons' obsession with home ownership blossomed in the early 80s with the sale of council houses. "I have never lost my bias towards home ownership. What we did in the Eighties has made our society more attractive, as it brings with it a sense of real belonging. But the obsession with home ownership isn't totally healthy. It is not good to extend home ownership to people who simply can't afford it.

"Britons put so much faith in all things property related because they view the alternative investments as a bit of a dead loss ... they have lost all confidence in pensions, life insurance firms (following Equitable Life) the stock market and even – after Northern Rock – bank and building society savings. For many people their property is their pension.

"However, there is a real danger that unless we stop housing-market volatility, people will eventually feel the same about property as they do about pensions, savings and, to a certain extent, shares. If they lose out this time around the public could lose faith in property."

Mr Clarke says he is now looking nervously over the Atlantic at the housing market horror story unfolding. "This was sparked by completely mad bankers loaning money to people with very little or no income, so-called Ninja (no income, no job or assets) home loans. We are all paying the consequences now and it could get worse.

"One possible silver lining for the UK is that we don't have the excess in supply of houses here as in US, Ireland and Spain – but we do have a glut of flats outside London, and government plans for lots more starter homes won't help matters as few people want to stay in them for any length of time."

As for what can be done to stave off a crash, Mr Clarke says the market has to be largely allowed to play out, but the Bank of England, which cut UK interest rates last week by 0.25 per cent to 5 per cent, should be more prepared to cut rates to underpin confidence in the housing market, even if it means missing its inflation target.

"When the Bank sets interest rates its No 1 priority should be controlling inflation, but it shouldn't be too narrow in this. When it sees something strange happening to the housing market, as we've had in the past few months, then it should look to move rates. The housing market is such an important part of the economy."

As for the turmoil currently gripping the mortgage market – roughly three-quarters of all mortgage deals have been withdrawn since last autumn and rates for people remortgaging are rising sharply – for Mr Clarke this is just a necessary return to more normal lending. But it still hasn't gone far enough.:

"What we need is stability. I don't understand why any lenders are giving out mortgages at a loan to value (LTV) of 95 per cent. At this point in the cycle they should lending at no more than 80 per cent LTV and no more than three times salary. That's the way the market used to be."

In calling for banks to be more cautious in their lending Mr Clarke is in a way echoing comments made by the Chancellor, Alistair Darling, in the immediate aftermath of the Northern Rock crisis, that the UK needs a return to "old-fashioned banking" practices. At the time, Mr Darling was derided by many commentators for pointlessly wishing to rekindle a bygone era.

But Mr Clarke says keeping a cap on mortgage lending is crucial to avoiding future housing crashes, although this time it's a case of bolting the stable door. Key to limiting loans should be a tougher approach taken by the Financial Services Authority (FSA) that regulates the mortgage market, Mr Clarke says.

"The FSA needs to raise its game. Part of its duty of care should be to look at unwise lending policies. They failed to query Northern Rock's reckless lending with terrible consequences. When the FSA sees banks lending at too high a loan to value or too high an income multiple, such as five times salary, they need to say 'hold on'."

Recently, a report into the FSA's handling of Northern Rock was highly critical of the regulator, suggesting it had been "asleep on the job" and failing to meet regularly enough with the board of the Rock, which prior to its demise was the UK's fastest growing lender.

But Mr Clarke lays much of the blame for Britons' debt splurge and any impending house price crash at the door of Mr Darling's boss and predecessor, Gordon Brown: "He ignored the warnings that personal debt was getting way out of hand, and as for the Government's finances, huge deficits have been run up. This means there is less money available to spend now that the economy is in trouble. From about 2002 onwards, Brown has been an old-fashioned tax-and-spend Chancellor."

If house prices do crash, Mr Clarke reckons the consequences may be felt not just in the households of millions of Britons but also in the ballot box, perhaps as early as next month's local elections: "Middle Britain feels that it has been left in a mess. In my experience when people hurt financially they tend to punish those in charge."

No doubt he's thinking of his own frontbench days: the last time house prices crashed the Tories were booted out at the next election in a Labour landslide.

Buy, sell or rent?

The first-time buyer

Funda Cizgenakad, 33, from Putney, south-west London, says: "My intention was to buy early this year, as I'd had enough of renting." She now thinks it best to delay. "I think I should sit tight for a year or so and see what happens, as if prices fall I will be in a much better position."

The young family

Matt and Emma Northover, 29 and 31 respectively, from Purley, say: "We want to move soon, but we fear falling house prices eroding the equity we've built up. We may be not be able to afford to move with a looming recession. Sometimes, it seems Britain's property ownership obsession does us no good."

Harriet Meyer

Questions & answers: What does the credit crunch mean for my housing hopes?

Are house prices falling?

Yes. Halifax said they fell by 2.5 per cent last month alone. The price slide, under way since the autumn, is gathering pace.

Why are prices falling?

Prices had become unaffordable. An average UK home costs £200,000, roughly seven times average salary. House prices needed a breather to allow incomes to catch up, but that has turned into big price falls with the credit crunch.

What effect has the crunch had?

Banks, struggling to raise money themselves, have become more reluctant to offer mortgages. This reduces the number of people who can afford to buy. Fewer buyers means properties remain unsold and this, in turn, means sellers slash their prices. The lower prices sink the less happy lenders are to risk money secured against property.

How low could prices go?

Opinion is divided. Lenders such as the Nationwide and Halifax say that prices will only fall a little as the economy is OK and employment high. Outside forecasters are much gloomier. Capital Economics sees prices falling by 20 or 25 per cent in the next 18 months. Some big lenders are bracing themselves for falls of around a quarter – nearly as bad as the market crash of the early 1990s.

How do falling prices affect me?

It depends on your circumstances. If you need to sell, you will get less cash for your own home if you can sell at all. If you've bought recently, expect to be in negative equity.

How long could price falls last?

Again opinion is divided. Some experts reckon it could all be done and dusted in under a year. They say that the credit crunch will ease, mortgages will become more available and this will permit people to buy again. However, past experience shows that when confidence is undermined, prices slide further and for longer than predicted.

Should I worry about my interest-only mortgage?

Yes. At the end of your mortgage term you will have to find a large amount of cash in one go. Most experts reckon that people with interest-only mortgages should switch to repayment and start reducing their debt.

I am keen to buy my first home. Falling prices are good news, aren't they?

Normally. It means more first-time buyers can afford to buy, and this boosts demand. But this time things could be different. Banks, spooked by the credit crunch and falling prices, have been pulling mortgages tailored to first- time buyers. As a result, first-timers need a much bigger deposit and will be barred from borrowing many times their salary. So even if prices fall substantially, would-be first-timers may find that they can't raise enough cash.

Am I better off renting?

Rental agents report a surge in custom from people who can't afford to buy because of the credit crunch. As a consequence, rents are rising sharply. However, people who choose to rent rather than buy should benefit as house-price falls should make it cheaper for them when they decide to climb back on to the property ladder. Some believe, however, that the UK economy would be better if we ditched the obsession with home ownership and if more people rented instead. Housing market boom and bust can be very damaging.

Julian Knight