Interest rates - the ticking time bomb

But, according to Hometrack, 31 per cent of postcodes registered an increase in prices in June - the highest since September 2007. And all the other indicators like time on the market and percentage of asking price achieved are supportive of the idea that the housing market is taking off again.

Of course, in a normal market, the rise in house prices is governed by the ability of potential buyers to afford higher prices and their success in securing adequate mortgage finance. Assuming that banks are not going to lend on exotic earnings multiples, first-time buyers will be facing a clearly defined price ceiling. But the problem of raising a deposit sufficiently large enough to meet the risk-averse stance adopted by mainstream banks has, until very recently, been the major problem. Now, the government's Help to Buy scheme has solved this hurdle overnight.

If, as demand starts to exceed supply while housebuilders grapple with the still asthmatic planning procedure, prices start to rise, will this be a problem?

Taking an example, at 3.27 per cent, a repayment mortgage on £100,000 over 25 years would cost £489 per month. Factor in a 20 per cent increase in the mortgage requirement, and the monthly repayment would go up by £98 to £587. That's less than £25 a week which, although a nuisance, shouldn't be a challenge, not least because borrowers should not operate on such slim margins of error. So some house price inflation would not be a major problem for new house buyers.

The other variable is interest rates, and this could be where the real problem lies. Interest rates in the UK are as low as they ever have been, and it seems unlikely that the fragile pace of economic recovery will allow a rise in rates for a few years yet. But what happens then? As the table shows, an increase in the mortgage rate to 5 per cent would cost an extra £96 - not so bad. But a rise to 7 per cent would really hurt. And I have included the absurd cost of a mortgage at 15 per cent because that is what everyone had to pay in 1979.

So we shouldn't worry too much about house price inflation, but we could have a problem if the bank rate increases substantially. The worry is what happens with interest rates when the economic recovery starts to accelerate, and also what happens in three years from now when the Help to Buy scheme is supposed to be wound up. This will take some careful handling because those with long memories will remember MIRAS or mortgage interest relief at source. This was a tax allowance on mortgage interest payments on the first £30,000 of a mortgage. In 1983, legislation allowed married couples to pool their allowance to £60,000. But in the 1988 budget this option was ended, but not until five months later. And the resulting stampede to beat the deadline was largely accountable for a subsequent bubble in house prices.