Is throwing money at the mortgage market the solution?
You may have noticed over the last month many countries have past bills in their governments to inject substantial amounts of cash into their banking system. They have done this on the understanding that all the bad loans also known as toxic debt is weakening the institutions and rendering us unable to borrow money so leaving us all worse off as a result.
But the big question on everyone's lips is, will this have the effect of kick starting the institutions lending again, and if it does, what how will it affect the individual and the public in general. The analysis off this problem will be based on the UK as that is where my financial experience stems. The situation within the UK may bare similarities with that of other countries but I am not in the position to comment on whether the outcomes would be similar or not because I would not be as au fait as to how their markets tend to function.
Now the general consensus would be that due to the credit crunch the various financial institutions involved in the lending of money are not at liberty to do so, through a lack of it. So it would then follow on that the way to solve the problem is to supply them with the necessary means, i.e. more money. But this approach does not begin to scratch the surface with regards to the underlying problem. The reality is that the banks have been badly hit by the credit crunch and so are quite unwilling to continue on with lending as if nothing had happened.
House prices are the most important element of the current financial situation, and the prices are dropping fast and are showing no sign of stopping any time soon. Because of this drop in value, lenders are having to be extra vigilant when it comes to lending money from now on. This is particularly relevant when it comes to loan to value (LTV), which is the amount lent in relation to the value of the property. For example, in 2007, lenders were giving 95%, 100% and even 125% of the value of properties.
Now in a healthy market there is nothing wrong with this type of lending. For example, if you give a 125% loan on a house valued at 100,000 then the resulting loan would work out at 125,000. With a buoyant market the house prices may increase at an average of 10% per annum over the next three years. The resulting LTV would equate to 93%. So mathematically we can see that there would be nothing wrong with the initial 125% loan in that there would be negligible risk involved.
But the problem that we face is that house prices are going in the opposite direction. The decline is at least 10% and analysts figure that it could get worse. So, if 100,000 was lent on an 85,000 property then in the same three year time span the loan could have actually increased to 118% LTV. Now I am sure you would agree that in this present climate that this sort of loaning is both irresponsible and detrimental to all involved.
So what does the future hold for the market and will the bailout be the solution to the problem. Well I can only give my own personal professional opinion and nothing is set in stone but realistically I would perceive the bailout as having very little effect. They simply cannot lend at the high loan to values even though they have been committed in 2009 to lend at the levels reached in 2007. You see the majority of loans being agreed at present are dealing with people coming out of rates that had been pre-arranged over the last 5 years. Due to the downward spiral of house prices these people are going to be pushing the LTV up.
Another thing to consider is the high amount of self certification mortgages that have been arranged over the last 5 years. These types of mortgages will definitely be a rarity because they are seen as to high a risk and the institutions don?t want to know. And even if they are available the LTV will be far lower so what are the consequences in that scenario?
So whilst I do welcome the money that is being injected into the finance market I sadly think that whilst property continues to fall and lenders fail to have the pre 2008 appetite for lending it is more than likely just going to be stockpiled. This will have a domino effect as house prices will continue to fall because of the lack of lending at the right LTV with the right lending criteria which again will make lenders even less willing to lend. I have to say this is quite a quandary and I honestly don't see how it can be stopped until someone has the bravery to just lend knowing the calculated risk it represents I think it is fondly known as taking a punt!.
But the big question on everyone's lips is, will this have the effect of kick starting the institutions lending again, and if it does, what how will it affect the individual and the public in general. The analysis off this problem will be based on the UK as that is where my financial experience stems. The situation within the UK may bare similarities with that of other countries but I am not in the position to comment on whether the outcomes would be similar or not because I would not be as au fait as to how their markets tend to function.
Now the general consensus would be that due to the credit crunch the various financial institutions involved in the lending of money are not at liberty to do so, through a lack of it. So it would then follow on that the way to solve the problem is to supply them with the necessary means, i.e. more money. But this approach does not begin to scratch the surface with regards to the underlying problem. The reality is that the banks have been badly hit by the credit crunch and so are quite unwilling to continue on with lending as if nothing had happened.
House prices are the most important element of the current financial situation, and the prices are dropping fast and are showing no sign of stopping any time soon. Because of this drop in value, lenders are having to be extra vigilant when it comes to lending money from now on. This is particularly relevant when it comes to loan to value (LTV), which is the amount lent in relation to the value of the property. For example, in 2007, lenders were giving 95%, 100% and even 125% of the value of properties.
Now in a healthy market there is nothing wrong with this type of lending. For example, if you give a 125% loan on a house valued at 100,000 then the resulting loan would work out at 125,000. With a buoyant market the house prices may increase at an average of 10% per annum over the next three years. The resulting LTV would equate to 93%. So mathematically we can see that there would be nothing wrong with the initial 125% loan in that there would be negligible risk involved.
But the problem that we face is that house prices are going in the opposite direction. The decline is at least 10% and analysts figure that it could get worse. So, if 100,000 was lent on an 85,000 property then in the same three year time span the loan could have actually increased to 118% LTV. Now I am sure you would agree that in this present climate that this sort of loaning is both irresponsible and detrimental to all involved.
So what does the future hold for the market and will the bailout be the solution to the problem. Well I can only give my own personal professional opinion and nothing is set in stone but realistically I would perceive the bailout as having very little effect. They simply cannot lend at the high loan to values even though they have been committed in 2009 to lend at the levels reached in 2007. You see the majority of loans being agreed at present are dealing with people coming out of rates that had been pre-arranged over the last 5 years. Due to the downward spiral of house prices these people are going to be pushing the LTV up.
Another thing to consider is the high amount of self certification mortgages that have been arranged over the last 5 years. These types of mortgages will definitely be a rarity because they are seen as to high a risk and the institutions don?t want to know. And even if they are available the LTV will be far lower so what are the consequences in that scenario?
So whilst I do welcome the money that is being injected into the finance market I sadly think that whilst property continues to fall and lenders fail to have the pre 2008 appetite for lending it is more than likely just going to be stockpiled. This will have a domino effect as house prices will continue to fall because of the lack of lending at the right LTV with the right lending criteria which again will make lenders even less willing to lend. I have to say this is quite a quandary and I honestly don't see how it can be stopped until someone has the bravery to just lend knowing the calculated risk it represents I think it is fondly known as taking a punt!.
About the Author:
Mortgage Route offers information help and mortgage advice from fully trained mortgage brokers coupled with free mortgage calculators and sourcing tools.
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2:39 AM
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