Buy-to-let misery

Have you noticed how in the furore that has overtaken the financial markets in the past few weeks, the focus of blame has been – rightly, I suppose – on greedy bankers.

There is no doubt that those who lent recklessly in the housing market over the past 10 years should be castigated for pursuing lending policies that were only storing up trouble for the future.

But it takes two make a loan transaction – the lender and the borrower. What of the tens of thousands of buy-to-let borrowers in the past few years? Did they really think they were engaged in a one-way bet?

The proposal was simple. You went to a bank or building society and borrowed the full mortgage on a £100,000 apartment, say. You then rented out the flat to cover the mortgage and, in time, you could sell it at a profit and pocket the capital gain.

In a rising market the prospect seemed viable and, as the market continued to rise beyond all expectations, it grew increasingly attractive. Lenders were happy, because, although they knew there was a risk, they considered that their mainly middle-class borrowers – often with properties of their own – were good for the credit since their earnings would underpin repayments.

But the lenders were so happy they stopped worrying too much about the potential creditworthiness of the borrowers or, indeed, about the value of the property, sometimes lending over and above its value.

In the US this recklessness was taken to extremes on a scale far beyond that in the UK. So it it’s no surprise that when the housing market stalled people began to default on mortgages and what had seemed a lending bonanza turned to junk in a matter of months. It was then that we began to hear much about what the Americans called the “sub-prime” market – house lending to people with poor credit prospects.

As the housing market faltered in the UK those with buy-to-let arrangements began to struggle. Many of these people have indeed decided to dig-in for the long run, taking the loss on their properties. If they bought a few years ago they are probably still holding a capital gain, but the more the market falls, the longer the slump continues, the more they may see this gain dwindle.

Moreover, if at the same time they lose their tenants, or if the rental market declines so that mortgage payments are no longer covered by rents, the buy-to-let speculators face ever increasing burdens in servicing their debt. This is when the market begins to unravel.

It doesn’t take too many foreclosures to force more property on to an already flabby market, driving prices lower, allowing those who do want property to cherry pick their rents or force hard bargains on sales.

I remember the last housing slump in the late 1980s and early 1990s. I know people who held on to their properties, turning down offers which they thought poor, then taking lower offers a year later. When prices begin to fall like this the market usually gets worse before it gets better.

The main point I want to make here, however, is that the greed underpinning this latest financial crisis is distributed far beyond the doors of the banks. That said, while some of those who thought the sun would shine forever could be forgiven their ignorance, the lenders should have known better.

Whatever happened to the sound principles of lending to people with collateral? It is a fundamental principle of lending that you minimise your risk and you do that by assessing people’s ability to service their debt over the long term or, when handing out mortgages, ensuring that a property is worth a good deal more than the loan sum in the event of repossession.

I’m not a financially sophisticated person. But I know that much.