The charge of the house price

The price of housing has been increasing steadily for well over a decade now, and although commentators frequently foretell of an imminent crash, there is little in the way of empirical evidence to back up this prediction. What we do have however, is a house price index increasingly divergent from the increase in wages. In 1984, the average house cost 3.4 times the average wage (HBOS index). By 2005, this had nearly doubled to 6.1 times the average wage. Plotted on a graph, the house price index has a disconcertingly exponential feel to it. Disconcerting, that is, for those people trying to get a hold on that slippery first rung of the property ladder.

Interest rate rises in August and November are yet to make a serious impact on the seemingly unstoppable charge of the house price, which is it at its most rampant in Greater London. There are even whisperings that fiscal policy may not be working anymore, and that a 0.25% increase in interest is going to do little do dissuade a borrower already saddled with a seemingly insurmountable debt. The first house price index to take November's interest hike into account, compiled by 'Rightmove', showed a monthly increase of 1.5% between October and November, which brings the average price of a house up to a record £222,333.

The standard supply and demand model can go some way to explaining the continued buoyancy of the UK housing market. Every year in England around 155,000 new households are created, but the number of new homes built is nearer to 120,000. This shortage, which is particularly severe in the South East, means demand hugely outstrips supply; resulting in high prices. There are a range of economic, social and geographical factors contributing to this discrepancy.

• The continuing growth of the British economy means that parts of society are experiencing a surge in income, and deem property a sound investment. Whether it is a second home in the Lake District, or a terraced inner city house to let to students, the number of second properties in the UK is at all time high.

• Although the large number of Eastern European immigrants arriving in the UK every year may not necessarily be looking to buy a property, they certainly increase demand in the rentals market, keeping buy-to-let an attractive prospect for investors.

• The demographics and changing family structures of the country are perhaps the weightiest factors keeping demand for housing steadily increasing. The number of properties occupied by just one person was around 20 million in 1990, and is projected to hit 25 million in 2020 (Source; DCLG). This trend is reinforced by a 2005 study carried out by the Economic and Social Research council, which found that since 1971, the population of the UK has increased by 5%, but the number of single households has increased by 31%. This is partly due to the fact that young people often desire to live alone before they marry, and partly due to the ageing population of the country.

Competing to give debt

We have established that demand for housing is high, indeed far higher than supply, and this keeps prices rising out of step with wages. However, despite the fact that homes are increasingly less affordable, more and more people are taking the plunge and buying their first property. Data from the Council of Mortgage Lenders shows that mortgage borrowing in October 2006 was up 12% from borrowing in 2005 to a record £33 billion, and an increasing proportion of these borrowers, up to 16.4 %, are first time buyers, theoretically the people who can least afford to get onto the ladder in times of high prices such as these. So how, and why, are all these homeowners managing to get onto the property ladder in such a competitive climate?

The answer lies in the UK's ultra competitive mortgage market. Comparatively free from regulation and encouraged to innovate, the 120 or so lenders in the UK are constantly looking for ways to expand their market share and attract borrowers. This has led to a huge, often baffling, range of products being offered to borrowers, and some dubious marketing schemes that have attracted criticism from the Financial Services Authority (FSA).

For example, some lenders employ psychological sales techniques that you might expect to find on a used car sales court rather than in a mortgage brokerage. A study conducted by John Ashton from the Centre for Competition Policy in conjunction with Leeds University found that a high proportion of lenders adjust their rates to make them seem more attractive, for example setting a rate at 4.99% instead of 5%. Conversely, rates on saving products are usually rounded up to whole figures. This behaviour has attracted criticism, because it is specifically targeting those who are less able to process number information, and quite often these are people who are in need of an affordable mortgage, rather than being duped into thinking they are getting something for less than they really are.

Certain types of mortgage may encourage borrowers to think about short-term gains rather than long-term affordability. Typically these are products that offer a very competitive fixed rate for a period of 2 or 3 years at the beginning of the mortgage period, then drastically increase monthly payment when the fixed term ends and the variable rates kicks in, which usually increases interest payments by around a third.