House prices could fall by 25% amid new lending rules may

THE housing market is on the precipice of a double dip as experts warn that new mortgage affordability rules could send house prices tumbling.

House prices have levelled out in recent weeks after more than a year of increases and as evidence mounts that the recovery has stumbled, a growing number of economists are predicting a sustained fall that could last for up to a decade and shave up to 25 per cent off prices.

New proposals unveiled this week by the City watchdog could strengthen the headwinds facing the housing market, it has been claimed. The Financial Services Authority (FSA) wants new affordability tests that would severely restrict the use of interest-only mortgages, making it harder for first-time buyers to get a home loan.

Under rules slated for implementation early next year, lenders will be forced to check every borrower's income in a move that will also bring an end to the practice of self-certification mortgages, designed to allow self-employed workers to state their own income.

The proposals have deepened the gloom in the housing market, following a third successive monthly fall in the Halifax house price index and figures from the Royal Institution of Chartered Surveyors this week showing buyer demand had slumped to its lowest point for two years in June.

A decline in the number of buyers suggests the imbalance between demand and supply that drove prices up last year is now being reversed and having the opposite effect, pushing prices back down.

That slump could be prolonged, PricewaterhouseCoopers has warned. It said there was a 70 per cent chance that the real cost of a property in 2015 would be below that in 2007 and a 50 per cent chance that it would take until 2020 for the market to surpass its previous peak.

John Hawksworth, head of macroeconomics at PwC, said: "Although the average house price over-valuation of around 25 per cent in mid-2007 is down to around 5 to 10 per cent despite the rally since March 2009, our analysis suggests that house prices remain vulnerable to setbacks.

"The possibility of a renewed fall in house prices over the next few years, particularly in real terms, cannot be ruled out as mortgage interest rates start to rise again."

Now the FSA has proposed introducing new rules that critics believe could further undermine the housing market. Experts warn that the clampdown on interest-only mortgages in particular will freeze out would-be buyers without significant upfront capital.

The availability of mortgages for first-time buyers with small deposits has dwindled since the end of 2007, with lenders focusing on low-risk borrowers with large deposits, despite signs of eased restrictions over the past three months.The average Scottish first-time buyer had to find 15,016 more for a deposit last year than in 2007, according to property data group Hometrack, after a 154 per cent hike since 2007 in the average deposit needed.

Melanie Bien, a director of mortgage broker Private Finance, said the housing market stands little chance of recovering without first-time buyers. "First-time buyers are the lifeblood of the property market.

"Since first-time buyer numbers declined dramatically, the level of transactions has also fallen sharply and people cannot move. It is causing big problems and it is hard to see how it is going to get any easier."

Those seeking a foothold on the ladder will increasingly need a sizeable deposit, a clean credit record and a repayment plan, she added. Those without face a long wait.

A spokesman for the Newcastle building Society suggested on Wednesday that first-time buyers without access to a generous "Bank of Mum and Dad" could be forced to rent or remain in their parents' homes for a decade longer than those with access to a decent deposit.

The FSA proposals may have a detrimental impact on homeowners as well as first-time buyers, according to Ray Boulger, senior technical manager at mortgage broker John Charcol. The changes could also end the practice of fast-tracking, where lenders speed up the application process for those with clean credit records and big deposits.

Mr Boulger said: "If lenders have to check all details on every borrower, it will delay all applications. Lenders have cut back on staff, but more checking will mean delays, meaning they will have to hire more staff, driving costs up."

Any increase in costs for lenders would come as they begin repaying funding support provided by the government when wholesale cash dried up at the outset of the credit crunch. The assistance, worth over 300 billion, was provided in 2008 to fill the gap.

Lenders will begin repaying the government support next year and Westminster has refused to commit to further assistance. The Council of Mortgage Lenders has warned that without a further capital injection and with wholesale markets yet to thaw, there is likely to be an intensification of the existing tight credit conditions.

Any lending drought would then have a detrimental impact on house prices,

Paul Diggle, property economist at Capital Economics, told The Scotsman that the situation could be exacerbated by the FSA's proposals, should they go ahead next year as proposed.

"Lending is already very constrained and the scarcity of lending will weigh on the market quite heavily in the next year," he said. "Restricted lending is the one thing preventing house price growth at a time when interest rates are so low."

Yet house prices are already ripe for a fall, Mr Diggle added, with the ratio of house prices to earnings currently indicating that prices are too high.If the link between house prices and earnings is restored, house prices need to go down by as much as 25 per cent, according to Mr Diggle.

"Currently house prices are over five times the average household income, but the historical average is 3.7. House prices would have to fall this year, next year and possibly in 2012 if that historic link is to be restored," said Mr Diggle.

David Morrans, independent financial adviser and director of Honour Financial Planning in Edinburgh, agreed: "I think house prices will fall - it's not a question of if but when because they are still way out of kilter with earnings and the glue that is holding the whole thing together is zero interest - and that is not going to last forever."