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FOOL'S EYE VIEW
When the last housing crash began, I watched it as an outsider at first. The UK housing market enjoyed a spectacular boom from 1984 to 1989, with the average UK house price rising 117% in just six years, according to the Halifax. However, it went too far too fast, and rising interest rates, reduced tax relief on mortgage interest and growing unemployment all took their toll. The housing market headed south until 1996, when the the latest boom began. I was made redundant just before Christmas 1990, and went on to qualify as a financial adviser in early 1991. However, I chose a bad time to enter this profession, as the sound of belts being tightened became almost deafening. Indeed, I struggled to make a decent living while still providing quality advice. Meanwhile, all around me, my hard-nosed colleagues were mis-selling products left, right and centre – their only concern being to hit their monthly commission targets! Hence, I quit my job as a financial adviser and went on to join the claims department of a leading payment protection insurance (PPI) provider, moving to its legal department shortly afterwards. I went on to serve eleven years in this industry before making parole in 2002 and joining the Fool in 2003. Free at last! During my time in the PPI market, I handled thousands of claims from people who needed help with their credit repayments, usually because they were sick or unemployed. This had a profound effect on me and taught me a few life lessons about personal finance, too. As I've repeated many times, I'm no economist, but I do see distinct similarities between this housing boom and the last. Of course, the economic conditions are very different: interest rates, unemployment and inflation are far lower these days. However, what worries me is that people's attitudes towards their household finances are starting to look dangerously similar to those that prevailed in the late Eighties and early Nineties. Here are some of the danger signs from the last housing crash that you should watch out for this time around: Second mortgages, secured loans and impaired-credit mortgages In 1991, mortgage lenders repossessed 75,540 homes - because the owners couldn't keep up repayments on a mortgage or other loan secured on their home. Last year, repossessions fell to just 6,230, or one in 1,850 homes, which is the lowest repossession rate since 1979. However, without a buoyant housing market to support struggling homeowners, I expect repossessions to bounce back with a vengeance, and the signs are that this about-turn has already begun. My professional dealings with homeowners from 1991 onwards gave me one important insight into the last housing crash. Many of my claimants were still keeping up repayments on their first mortgage – the home loan with which they bought their house - at all costs. What struck me was the number of people whose home was under threat from a second mortgage or secured loan. Indeed, almost every time that I found myself in court, repossession proceedings had been served by an impaired-credit lender, second mortgage lender or secured loan provider. Many of these charged sky-high interest rates, plus punitive penalties if a borrower was in arrears, which only made the problem worse and hastened repossession. Sadly, lending in these areas has been rising strongly during the current housing boom, so I expect many homeowners will come to regret their decision to borrow against their home. As I explained in this recent article, since the second half of 1998, we have withdraw £187 billion of our housing wealth, including over £55 billion in 2003 and almost £48 billion last year. This money wasn't reinvested in property, nor did it pay for home improvements or buy-to-let properties. Nope, we simply splurged it! If history repeats itself, the chickens will come home to roost for many of these MEWers (MEW is short for 'mortgage equity withdrawal'). That's why I'd avoid these top-up home loans like the plague. What's more, only house-purchase loans are covered by the tough mortgage regulations that were introduced last Halloween. So, although the Financial Services Authority has cleaned up the main market for mortgages, I'm willing to bet that there are some horror stories going on in its lightly regulated backwaters! Find a happier home loan in our Mortgage centre. Over-borrowing - a nation of 'credit junkies' Another characteristic shared by many of the people that I dealt with back in the early Nineties was their appetite for credit. Many had borrowed heavily to get on the housing ladder, leaving themselves with precious room for manoeuvre when Fate started tweaking noses. Here are some of the warning signs from back then that are creeping back into fashion today: Interest-only instead of repayment loans One risky move is to take out an interest-only mortgage without backing it with a suitable savings plan. Some borrowers do this because the higher monthly repayments demanded by a repayment mortgage would be a stretch too far. If you go down this route, you're not even on the margins of sensible homeownership (unless you're buying a buy-to-let property)! Spending too much of your wage on your mortgage In other words, forking out too high a proportion of your take-home pay on mortgage repayments is a no-no. Spending a third of your income on your mortgage alone would be risky. And yet some wild borrowers are willing to hand over half of their pay to a mortgage lender, so desperate are they to own their own home. Blimey, I wouldn't want to be in their shoes! A high loan-to-income ratio This means that your home loan amounts to a large multiple of your gross income. If your mortgage advance is more than, say, four times your salary, or 2½ times joint incomes, you're pushing it a bit. These – or even higher multiples of income - may be okay for young, high-flying professionals whose income is expected to soar, such as trainee solicitors, barristers or accountants. However, most workers would be wise to stick well within these multiples. Remember, they are limits, not targets! 100% (no-deposit) mortgages Try to put down a decent deposit when you buy. If you can't afford to hand over, say, a tenth of the purchase price (10%), it suggests that you haven't learned the budgeting and savings skills necessary to be a homeowner who can rest easy. Although a 100% mortgage can get you into your home today, it also means that you don't own any stake in your home. In other words, no-equity or low-equity mortgages are much riskier, because you haven't stumped up a sizeable deposit in order to buy a decent 'equity cushion'. This can be a problem when times get hard, because you have little or no equity to fall back on, so your lender won't cut you much slack. In addition, falling house prices could tip you into negative equity, where your home is worth less than your mortgage. And these mad mortgages, where you can borrow up to 125% of the value of your home, are plain bonkers! Lots of non-mortgage debt When I was processing sickness or unemployment claims in the Nineties, one thing that struck me was the number of claimants with multiple credit agreements. With some claims, my company was paying monthly benefits to five or more different insured loans or credit cards, plus the claimant's mortgage. Often, I found myself authorising four-figure monthly payouts to policyholders who had all their credit agreements covered by PPI. However, keeping on top of these claims was tough, as we had a huge backlog of work. Indeed, as a new recruit, I remember gawping open-mouthed at a pile of claim files about three feet high, which stretched about forty feet along the wall of our office basement! This wall of claims took thousands of hours of overtime to clear and cost my employer a fortune. Hence, word went out from the very top: we are paying out a fortune in claims and extra wages, so try to deny every claim that you can, however flimsy your excuse. So much for 'peace of mind'! This partly explains why I will never buy payment protection for as long as I live. The ridiculous cost of PPI is another reason, as I explain here (mortgages), here (personal loans) and here (credit cards). Of course, we are all credit junkies these days. Our credit- and store-card debt has exploded from £10 billion in April 1993 to around £55 billion today - annual growth of over 15% compound. We also owe a further £131 billion in other unsecured debts, such as personal and car loans, overdrafts, and so on. Oh, and our mortgage debt is £895 billion, which is £500 billion more than it was at the start of 2000. Not bad going, eh? Tiny or non-existent cash cushions A cash cushion is one of the comfiest things that you can own. With, say, three to six months' living expenses on deposit, you can ride out most short-term hits to your finances. This emergency fund or rainy-day money could be earning you tax-free interest of 5%+ a year in a cash mini-ISA. Alternatively, you could keep some in high-interest easy-access accounts – again, aim for an annual rate of 5% or more before tax. However, I guess that more than half of the claimants that I dealt with had less than one month's savings in the bank. In other words, if they were ill or unemployed for more than a month, they were up the proverbial creek without a paddle! Worryingly, I recall one piece of research a few years back from the Institute for Fiscal Studies, a financial think-tank. The IFS warned that the average UK household had liquid savings of £750 or less. Yikes – that's about two weeks' pay for the average worker! Sadly, we Brits have lost the savings habit. In fact, we save a much lower proportion of our disposable income than our cousins on the Continent, as this article demonstrates. However, we have much greater financial assets than other Europeans, which help to compensate for our poor state pension system. Furthermore, the UK's savings ratio – the proportion of our disposable income that we save – has been low for many years. Between 1990 and 1997, the savings ratio was never lower than 8% and peaked at 11.6%. However, between 1998 and 2004, it varied between 4.9% and 6.5%, and is currently 5.6%, which is much lower than its long-term average. So, if the economy continues to slow and our bills start to bite, we'll have precious little to fall back on unless we boost our savings beforehand! On the other hand, we have over £500 billion of cash savings, which comes to about £20,000 per household. Good news? Not exactly, because the vast bulk of this cash mountain is owned by just a few million well-off people, who make up the richest tenth (10%) of UK households! So, one way to avoid the worst repercussions of a housing downturn is to boost your personal balance sheet by borrowing less, clearing existing debt, and saving more. Even if we experience a 'gradual slowdown' or 'soft landing', as most vested interests in the housing market predict, getting the savings habit is never a bad move! Incredible interest rates await you in our Cash Mini-ISA and Savings centres! So, if you want to sleep easy in your home, make sure that you budget and spend sensibly, avoid running up big debts on your plastic, and don't borrow against your home. Armed with these financial skills, you should be able to avoid even the most severe financial hurricane! More: Find a better mortgage, cash mini-ISA, savings account, 0% credit card and personal loan. Cliff owns shares in HBOS, parent company of the Halifax. He recently sold his home, banked the profit and is renting a property while he builds a housing war chest!