The latest danger to house prices is the interest-only mortgage, says John Stepek in Monday’s Money Morning.
“Once deemed a perfectly sensible way to ‘get on the property ladder’, interest-only mortgages are now pariah products. Lenders around Britain are clamping down on their criteria for issuing them. Last week, Nationwide went even further. The building society has now stopped offering interest-only loans to new borrowers at all.”
So what does this mean for the housing market? John doesn’t think it will affect new lending. After all, “interest-only has already collapsed in terms of the share of new home loans issued. Nationwide might be the first to outright ban them, but most lenders have imposed such tight conditions on these loans that they are effectively banned”.
The people this really affects are the people who already have them.
Before the house price crash in 2008, you could chose between two basic types of mortgage. There was the standard home loan, where you paid off the interest and a bit of the principal every month; and the interest-only loan, where you just paid back the interest. At the end of the loan period you would have to pay back the principal in full.
“Clearly, the idea was that you would somehow be saving money for that day over the period of the mortgage”, says John. Unfortunately it didn’t always work like that. Indeed it’s estimated that one million interest-only mortgages will expire by 2020, with no repayment plan in place.
Some say this is yet another mis-selling scandal, but John doesn’t agree. “There is so much information available out there about home loans. I find it hard to believe that many of the people who took out interest-only loans didn’t understand what they were buying.”
The real reason that so many interest-only loans look set to fail is dodgy assumptions, says John. “They assumed that house prices would keep rising. They assumed that inflation would reduce the initial price of the house to a laughably small amount by the time redemption day came around in 25 years’ time. They assumed that ‘something would turn up’.”
But there’s no point dwelling on the past. The fact is that the banks don’t want these interest-only loans to cause more damage to already fragile balance sheets. And as they force borrowers out of this type of loan, the switch to a more expensive repayment loan will create ‘mortgage prisoners’. They will be “unable to move… making the market even more sluggish than it currently is. At worst, these people may lose their homes down the line, helping to push down prices overall.”
Our monetary system is deeply flawed
In Tuesday’s Money Morning, Dominic Frisby took apart the world’s ‘fiat’ money system.
“We’ve grown used to inflation. Our central bank explicitly wants prices to rise by 2% a year. Deflation – when prices fall – is deemed a threat to economic growth. Yet when gold and silver were officially used as money, prices were constant. In fact, according to the wholesale price index, prices actually drifted lower through the 19th century at a time when the Western world was enjoying great economic growth and prosperity.”
In 1971 the world made its final move away from gold, notes Dominic.
“The modern system of government fiduciary money – fiat currency – became the global norm. It wasn’t planned to any great extent. It happened out of political expediency. The US had issued more dollars than it had gold to back them, and was facing a run on its gold.”
The move has had a huge effect on prices, says Dominic.
“In 1971, I could have taken my son to the FA Cup Final for £2 (now over £100). The Mars Bar I bought him at half-time would be 2p (now 60p). The beer I bought myself would be 11p (now £5 a pint at Wembley). The gallon of petrol I needed to get me there and back would be 33p (now £7). And the house we went home to would be something like 40 times cheaper.” Basically everything apart from mass-produced goods has risen in price.
Meanwhile “average earnings have increased too, but not by the same multiples. They have risen from around £2,000 to about £25,000 today. The differential has been covered up by more debt, longer working hours, more women in the workplace, and so on.”
So if the ‘ordinary man’ has lost out from the new system of money, who has gained? “Those who control it, and those who are at or near its point of issuance”, says Dominic, “governments and banks, in other words. As well as enjoying a monopoly, they have the power to create money (whether by printing or through lending) and to charge interest on it. They also get to buy assets with their share of the newly minted money, before prices rise to reflect the new money in circulation.”
It’s a corrupt system, says Dominic, that transfers money from the many to the few.
“Most people spend a lot of time thinking about how to make more money. But not many people think about how money actually works – or how our system of money could be improved.”
Well, Dominic has given the matter some thought. In fact, he’s even written a book on it. He has some interesting suggestions on how the system could be reformed and on how you can protect your wealth, so Dominic Frisby took apart the world’s ‘fiat’ money system.
Mining jargon busted
You can fight back against fiat money’s flaws by investing your personal wealth in gold. And one man with plenty of ideas on how to do that is MoneyWeek’s gold mining expert, Simon Popple.
Simon concentrates on miners, calling them the “supply kings”. So far his tips have made healthy returns, and recently he found another firm with great potential (see below).
He also likes to break down some of the jargon used in the mining industry for investors so they are not bamboozled by mining marketing.
For example, he says investors may not know “there are three classes of resource (inferred, indicated and measured) and two classes of reserve (probable and proved). Which term should be used in a particular case hinges on the quantity, quality and scope of available information”.
It’s this type of explanation that should help you navigate the many news stories about some miner’s latest ‘mega find’.
The minnow that’s about to strike oil
Another man who knows his way around the resource sector is Tom Bulford, author of the Red Hot Penny Shares newsletter. He’s had a lot of past successes by picking tiny oil companies that have gone on to strike oil and make it big. In the last edition he told us about another small oil company that he thinks is about to take off.
“Every now and then I like to take a gamble in the oil sector”, says Tom. “Each time I take that gamble I’m conscious of all the things that can go wrong. Because however good the geology appears, however much preparatory work is done and however many miles of seismic data hint at what might be found thousands of feet below the earth’s surface, nobody knows what is down there until the first well is drilled.”
“So given the risks of oil exploration, the one thing I look for is a really big pay-off in the event of success. And today I want to recommend that you buy a penny share that could deliver a truly massive payoff.”
If its drilling schedule this year is successful it could rise 190%, says Tom. Meanwhile if all its plays yield the oil that geologists think they could – admittedly no certainty – the firm’s market value could increase 170-fold.
Five dates every shareholder should know
Another great way to get a financial education for free is to watch Tim Bennett’s video tutorials. For example this week a raft of FTSE 100 shares passed their ex-dividend date and subsequently dropped in price. Tim explains why and highlights four other dates that shareholders should add to their diaries: Five key dates every shareholder should know.
Right before I go, I’d just like to give a quick nod to the cover story in this week’s edition of MoneyWeek. It’s about driverless cars. That might sound futuristic but, as my colleague Matthew Partridge explains, there are already ways to make money from this exciting sector. If you’re already a subscriber you can read it here or if not, subscribe to MoneyWeek magazine.
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Have a great weekend!
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• This article is taken from the free investment email Money Morning. Sign up to Money Morning here .