House prices rose rapidly during the late 1990s and 2000s, increasing by 162% in real terms from the trough of the previous downturn in 1995 to the peak in 2007. A combination of falling interest rates, excessive credit supply, an under-supply of housing relative to demographic changes in some areas, and several other factors all helped drive house prices to new record highs (chart). There were growing concerns about the unaffordability of the market in the face of rising interest rates and by 2005 house prices were expected to stabilise.
However, house price growth picked up again during 2006 and it wasn’t until the credit crunch hit in 2007 that the market slowed. One of the first signs of trouble in the UK was the Northern Rock bank run in September 2007. Mortgage approvals collapsed by 72% from Q3 2007 to Q4 2008 (chart) and transactions fell by 61% over the same period (chart). House prices fell sharply during the early stages of the 2007-13 downturn, down by 20% in real terms and 19% in nominal terms over six quarters.
Nominal price falls were similar across all regions, except for Northern Ireland which had experienced a much larger boom immediately before the bust. There was a partial recovery in late 2009/early 2010 but real prices continued to fall in the second half of 2010. Real prices eventually hit a low in 2013, 26% below the 2007 peak. The variation in regional real house price falls reflects the earlier recovery in London and the south of England.
Mortgage lending criteria had loosened significantly in the run up to the 2007 peak. Falling interest rates had enabled borrowers to take out ever higher loan-to-income mortgages (chart) and many borrowers avoided proving their income by using self-certification mortgages. When the credit crunch hit, riskier mortgages disappeared from the market. This included higher loan-to-value ratio mortgages typically used by first time buyers while some borrowers became ‘mortgage prisoners’ due to their inability to refinance in the tougher lending market.
After the experience of the previous downturn, there were considerable efforts to avoid forced sales. The Bank of England initially reacted by cutting interest rates, to 5% by April 2008 and then substantially following the bankruptcy of Lehman Brothers in September 2008. Base rate finally reached 0.5% in March 2009, where it remained until the cut to 0.25% in the aftermath of the vote to leave the European Union. The cuts in base rate helped ease the financial pressures for the many borrowers, particularly those who had tracker or standard variable rate mortgages linked to base rate. This helped keep repossessions below the levels seen in the early 1990s (chart).
In the aftermath of the credit crunch, higher loan to value mortgages were limited and those that were still available came with much higher mortgage rates. For prospective first time buyers, the challenge was no longer the cost of owning but the cost of buying. Deposits as a percentage of income rocketed (chart) and help from the ‘Bank of Mum and Dad’ became essential for anyone looking to buy their first home.
Housebuilding had been below levels required to meet demographic change since the early 1990s but had just peaked at 200,000 homes in England in 2007/08. The recession hit and finance for development disappeared (chart) as completions fell by 41% (chart). In 2009 the government stepped in with funding via the Homes and Communities Agency (HCA). This funding was used by private developers and housing associations to continue development, in many case shifting development from market sale or shared ownership to affordable rental products. This was followed by the Kickstart programme and further money for new social housing. Unfortunately, these interventions were not enough to significantly increase housebuilding but may have prevented further declines in industry’s output.
With constrained housing delivery suppressing household formation (chart) and deposit affordability proving a big barrier to home-ownership, many people were forced to either stay at home or live in the private rented sector. Although the ONS private rental index shows real falls in rents during the recession (chart), there are suggestions this data may be flawed and private rents increased in markets with relatively stronger economies such as London. For those living in the social rented sector, rents continued to rise during a period when earnings were falling in real terms (chart), putting pressure on household finances.
Housing markets in central London continued to rise from the initial recovery in late 2009/early 2010 but house prices remained flat or falling across most of the country. In mid-2012, amid speculation over a double-dip recession, the Chancellor launched the Funding for Lending Scheme (FLS). While its direct effect can be questioned, its introduction sent a clear signal to lenders and others that the government was committed to maintaining house prices at or above their then level. This message was further reinforced with the announcement of Help-to-Buy in early 2013 and higher loan-to-value mortgages began to appear in the market. Real house prices hit their downturn low in early 2013 and began to recover.