How A House Price Cap Could Work

This article by Hilary Osborne of TheGuardian on September 13th, 2013 basically explores how a cap would work. The Royal Institution of Chartered Surveyors has called for the Bank of England to cap house-price rises at 5% a year.

Why does Rics want a cap?

The organisation says limiting house prices would prevent a dangerous new property bubble, reckless lending and a build-up in consumer debt. By letting people know that they can only expect prices to rise by up to 5%, the Bank of England would stop homebuyers and lenders gambling on rising prices. During the last property boom lenders such as Northern Rock offered 125% mortgages, based on an expectation that prices would rise and borrowers would not end up in negative equity for long – but when prices crashed some people were left stuck with huge loans. Rics argues that everyone would be more cautious if there was a price cap.

Why set it at 5%?

Rics says it is "not wedded" to the figure, which it based on the average annual growth in UK earnings, plus an allowance for price pressure caused by a lack of supply of homes for sale. Growth is currently exceeding that level, according to Halifax's latest house price index.

Is that the index that would be used?

Not necessarily. Rics has said it is "agnostic" about which measure of prices is used. The Bank has previously considered all of the major house price reports when making interest rate decisions, but there is now an "official" ONS index published monthly. Its last report showed prices rose by 3.1% in the 12 months to June.

If prices were capped, would that mean I would have to reduce the price of my house?

No. The cap wouldn't restrict individual buyers' and sellers' transactions, so if you were selling a property at a profit equivalent to more than 5% a year that would be fine. What the cap would do is force the Bank of England's new Financial Policy Committee to use powers it has to restrict mortgage lending.

What are those powers?

If it believes the housing market is overheating, it can direct the banking regulator, the new Prudential Regulatory Authority (PRA – also, confusingly, an arm of the Bank), to tighten the screw on mortgage lenders.

The PRA would use so-called sectoral capital requirements to give banks pause for thought before they make risky loans. They could force lenders to set aside more capital against all residential property lending, for example, if they thought the entire market was frothy – or pick on particular areas, such as high loan-to-value ratio mortgages. In practice, whichever types of loan the PRA singled out would become scarcer and more expensive.
  
What are the problems with a cap?

The main problem is that the headline rate of growth disguises massive regional variations. In the London market (itself a multiple of the entire New Zealand market) house price rises are already up 10.2% over the past year, according to the latest figures from the property portal Rightmove.co.uk. Yet in the north, north-west, Yorkshire and Humberside and south-west regions, house prices are up less than 1% over the past year.

Also, it does not address the real problem with the UK housing market – the lack of supply of properties.
  
So price rises in London could trigger a cap and stop me getting a mortgage in Newcastle?

Spot on. Houses in Newcastle could represent good value and be affordable to first-time buyers, but lenders would be constrained from granting loans if a London boom pushed up UK prices.

Article Source: http://www.theguardian.com/money/2013/sep/13/how-house-price-cap-work