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Why The UK Housing Market Experiences Boom and Bust Economic Cycles

A boom and bust cycles refers to the rapid increase in prices, followed by a period of falling house prices. This has occured on numerous occasions in the UK housing market, most notably during and after Lawson boom of the late 80s

Reasons For Boom and Bust

1. Limited Supply.

Many factors make it difficult for the market to build new houses. When house prices rise, we don’t see a corresponding increase in supply, simply because house builders take time to overcome planning restrictions. Therefore, any change in demand creates a volatile swing in prices. If supply were elastic this wouldn’t occur. Local councils have a strong ability to restrict the number of new houses built. Local councils also have an incentive to stop houses being built, because voters prefer less supply and higher prices for their existing homes.

2. Changing Interest rates.

Most homeowners in the UK choose a variable mortgage. This means that as the Bank of England base rate changes, their monthly repayments change as well. Therefore, a small increase in interest rates can have a big impact on people’s mortgage interest payments. If interest rates increase, then people may struggle to meet their mortgage commitments and therefore, will have to sell. Because Mortgage payments are a big % of income,  this is a serious problem for many homeowners.

• In other countries, more homeowners choose fixed rate mortgages; therefore, they are less sensitive to interest rate changes.

3. Buyers take out Large Mortgage to Get on Property Ladder.

Because UK house prices are so expensive, people have been taking out unconventional mortgages to be able to afford a house. These mortgages are a high ratio compared to their income. This means that mortgage payments take nearly 50% of people’s disposable income. Therefore, it is easy for mortgages to become unaffordable.

4. Volatility in Mortgage Lending.

One of the biggest reason for the current volatility in house prices, is the uncertainty in the mortgage sector. In 2006-07 mortgage lending was relaxed; low deposits were needed; banks were willing to lend high loans to income ratio. However, after the credit crisis, mortgage finance has been drying up and many potential homeowners are no longer able to get the necessary mortgage finance to buy.

5. Boom and Bust in Economic Cycle.

If the economy goes into recession, demand for houses will fall. When growth is high, people have the confidence to borrow more. Demand tends to be income elastic. However, house prices falls in 2008 are due to other factors.

6. Speculators

Rising prices encourage people to try and make capital gains. They buy houses to gain income and a rise in the value of housing. When prices are rising, there are more buy to let investors pushing up prices. But, when prices fall, speculators are likely to sell their houses and prevent a fall in wealth.

7. Poor Memories.

People often have poor memories and during a boom forget that house prices can fall. They assume that house prices will go on rising forever.