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Homeowners paying off mortgages at record rate

In 2010, homeowners paid back over £24bn of their mortgage borrowings, which was the highest amount since records began in 1970. Detailed figures from the Bank of England also showed that £7bn was repaid in the final quarter of 2010, compared to £6.6bn in the third quarter.

This means that mortgage repayments have exceeded borrowings for eleven consecutive quarters. This is in stark contrast to the period from July 1998 to March 2008 when homeowners actually borrowed a total of £328bn in what is called housing equity withdrawal.

This was at a time of rapidly rising house prices, and homeowners felt a wealth effect which they wanted to enjoy in money terms. They therefore borrowed against the appreciating value of their homes, by taking out additional mortgage borrowing, and then spent it on cars, holidays and other luxury items. The recent trend can be seen in the figure below.

Source: Bank of England

So, why have homeowners decided to reduce their mortgages by paying back additional amounts, since the end of the recession? In fact, they have paid back £57.4bn since the second quarter of 2008. There are several reasons for this.

Firstly, it is far more difficult to borrow now than before the recession, as mortgage lenders have tightened their lending criteria. This means that the opportunity for housing equity withdrawal has largely disappeared.

Secondly, mortgage interest payments have dropped to very low levels, with many homeowners deciding to keep up the nominal amounts they were used to paying for their mortgage, with the result that they will pay off their mortgage much quicker than anticipated.

And thirdly, interest rates on savings are at record lows. This means a reduced opportunity cost of taking money out of savings and using it to bring down outstanding mortgages.

But what are the consequences of this housing equity reversal? In the years before the recession, at a time of ever-rising house prices, homeowners housing equity withdrawal rose to the equivalent of 9% of post-tax incomes. Now, homeowners are shelling out the equivalent of 2.7% of post-tax incomes to reduce their mortgages.

Unfortunately, this net injection of housing equity is taking money out of the economy. Money which would have been spent on consumption is not now being spent. This is not going to help economic growth and may have further consequences for higher unemployment.

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Posted in Household wealth, Housing, Interest rates

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