Personal Finance: Enticing incentives

Like most people who should know better, I spend far too much of my time thinking about house prices, mortgages and the outlook for the housing market. My New Year resolution is to treat all news about trends in house prices and mortgages as an interesting curiosity which should mainly be ignored, though once in a blue moon may be worth doing something about.

This is sound advice, but not so easy to put into practice. Which is why, before taking my vow of abstinence on the subject, I cannot resist commenting on a new piece of research about the medium term outlook for house prices and the mortgage market from Lombard Street Research, Professor Tim Congdon's economics consultancy. The report, by Stewart Robertson, is one of the best and most closely argued analyses of the mortgage market that I have seen in ages.

Mr Robertson's analysis effectively makes the case that the buyers' market of the last two to three years - the period of cashbacks, flexible mortgages and all the other new incentives dangled before the would be mortgage borrower - is likely to endure for some while yet. His argument goes as follows.

On the borrowers' side (that's you and me), the demand for mortgages is likely to remain subdued for several years. The main reason is that as a nation we are still far more in debt to mortgage lenders than we wish (and perhaps ought) to be. The profound effects of the house price crash in the first half of the 1990s, which plunged thousands into negative equity, and overextended many others, have yet to play themselves out.

It is true that, thanks to the welcome revival in the housing market since 1995, negative equity is now largely now a thing of the past. But it remains the case that mortgage borrowing is still at unprecedentedly high levels, almost any way you care to measure it. As the chart shows, the ratio of mortgage debt to housing equity (that is, the proportion of the value of our houses which is financed by mortgages) is still around 50 per cent, well above the long-run historical average of 30 per cent.

Meanwhile, two other powerful forces are working to restrain mortgage demand. One is the cumulative effect of the phasing out by successive governments of MIRAS tax relief. The demise of MIRAS has substantially reduced the tax advantages of borrowing to buy property, but it has taken time for homeowners to wake up to quite what a difference the ending of Miras has made to the cost of buying property, particularly for higher rate taxpayers.

The other factor is the potential impact on housing demand of the changing pattern in population growth. The number of first time buyers in the housing market is now starting to decline. First time buyers are the marginal buyers who set the pattern for housing market demand, and they are a diminishing band. This too can only put further downward pressure on future demand for mortgages.

While the demand for mortgages is therefore likely to remain subdued for several years, it is doing so at a time when banks and building societies have also built up record amounts of capital which they now need to deploy profitably. A significant chunk of this capital has been devoted to winning a share of the mortgage market over the last 15 years, and there is as yet no sign of the drive for new business alleviating - if anything, rather the opposite.

Mr Robertson argues, convincingly to my mind, that the combination of weak mortgage demand and a surplus of capital in the banking sector can have only one consequence. If his analysis is even half way correct, what it suggests is that the battle for mortgage seeker's business is going to remain intense.

He sees a continuation of today's market in which mortgage seekers - especially first-time or new borrowers - continue to find themselves knocking at a virtually open door.

Most of the benefits of the struggle for market share in mortgages so far have gone to first time buyers, but Mr Robertson predicts that we will also see much more remortgaging activity by existing borrowers as more and more people come to realise the benefit of switching their mortgages, and the extent of cross-subsidy from existing to new borrowers becomes widely known.

Mr Robertson thinks that those best placed to benefit from these market conditions will be the surviving mutual building societies. His analysis shows that, since 1996, mutual societies have been taking a growing share of new mortgage business from the banks. The mutual societies have both the greatest incentive and the greatest opportunity to go on doing so, should a price war develop.

In Lombard Street Research's view (as in mine), barring a bad recession there are solid reasons to expect a period of house price increases over the next few years. However, as most people still feel they have more mortgage debt than they would like, or are used to, the emphasis for most people will be on repaying or refinancing mortgages, rather than raising their overall mortgage borrowing. This will be a tough environment for lenders, but will present an opportunity for borrowers to get some outstanding deals on their mortgage. Your New Year Resolution, therefore, should be to make sure you are ready to cash in on these favourable conditions as long as they last.

`Strategic Analysis of the UK Mortgage Market', by Stewart Robertson, is

published by FT Business

Jonathan Davis can be contacted via e-mail at: davisbiz@aol.com