Are we facing another house price crash?(Image: John Giles - PA Wire)

Image: John Giles - PA Wire

Property prices by most measures bottomed in April last year and have been bouncing back since then. Prices are still a good bit below the peak, but they've come back pretty strongly.

But 2010 has got off to a tough start: the Halifax and Nationwide house price indices suggested that prices fell in February, breaking a long run of monthly increases, and the number of deals done in January took a dive.

So are we at the start of another house price crash? Or is this just a blip in the long-term upward march of British property prices?

Check out what homes are selling for near you

Blame the snow
I'm pretty pessimistic about house prices, as you might have noticed if you've read some of my previous columns. And if you're of a pessimistic disposition, it's easy to jump on negative data as supporting your case, just as optimists over-exaggerate the significance of positive data.

It's hard to say whether the start of this year represents a turning point or not. Mortgage approvals dived by 17% in January, falling from 58,000 to 48,000 or so. And Halifax and Nationwide said that the average rate of house price growth has been slipping since the last quarter of 2009.

According to the Royal Institution of Chartered Surveyors, the number of potential buyers fell in January, while the number of properties coming onto the market kept rising.

However, there's no doubt that the bad weather in January will have had at least some impact. It may be convenient for the estate agents and other property pundits to blame bad news on the snow, but winter is hardly boom time for the housing market anyway.

The end of the stamp duty holiday won't have helped either, with the threshold now starting at £125,000 again, from £175,000 before. And, of course, it's never a good idea to look for a trend from one month's data. So I'm not going to say that this is definitely the turning point.

But house prices are going to fall further. I think a second crash, probably kicking off this year, is very likely. Here's why:

What makes house prices rise?
Before we know why house prices will fall, we have to understand why they go up in the first place. So why do they go up? If you answered "supply and demand", you're half-right. It is supply and demand. But it's not about the supply of property - it's about the supply of credit.

Nonsense, say the optimists, Britain is a small overcrowded island and, to cap it all, every foreigner in the world wishes they lived in dear old Blighty. If I had a penny for every time I've heard this argument, I'd be rich enough to buy - well, maybe an average UK property.

It makes intuitive sense. But like many things that make intuitive sense, if you look at the data, you realise it's rubbish. If there was a genuine shortage of property, British rental costs would have risen in line with house prices.

They haven't. It's hard to find objective data on rents, but FindaProperty.com has been doing a monthly survey since January 2008. In that time, the average rental charge has fallen from £873 a month to £814 now, while the number of properties available has nearly tripled.

And history shows that crashes happen in places with populations just as dense as ours. There's the uber-crash that Japan saw: prices dived by nearly 70% and haven't really come back. Hong Kong, one of the most densely populated areas in the world, saw property prices surge by 50% from 1995 to 1997, before falling by 57% from 1997 to 2002.

Perhaps more obviously, the US hardly lacks space. But that didn't stop it from having a huge housing bubble which popped in 2006 and is only now showing any signs at all of bottoming out.

The real rocket fuel for a house price bubble is cheap and easy credit: people buy houses with borrowed money, people always want the best and biggest house they can afford. So, by and large, the main cap on what an individual will pay for a house is the ceiling on what the bank will lend to them.

Are you overpaying on your mortgage? Compare deals now

So what's going to happen to credit?
Let's start by pointing out something that's easy to forget. The housing market is not remotely normal just now. People fixate on house prices, which are rebounding. But that's about it. The number of sales going through is still lower than at any point during the previous house price crash of the 1990s.

What's happening? Well, on the one hand, very few people are being forced to sell. Ultra-low interest rates mean that most people will find that even if they've been kicked off a fixed-rate mortgage, their mortgage bills will have fallen.

And the cost of living fell during late 2008 and early 2009, along with interest rates and oil prices. So the payment shock time bomb that some had predicted is yet to go off.

But moving house or trading up is a different kettle of fish: the banks will lend - but only cheaply if you have a chunky deposit of 25% or more and a gleaming shiny credit history. And about a third of sales going through right now are cash sales, according to the Land Registry.

So on the sales side, no one is being forced out of their homes. But they can't afford to move either, because it would mean applying for a new mortgage which they might not get.

And on the demand side? The few people who can get decent credit are chasing the few quality properties that are on the market. Hence, prices are being propped up.

Either interest rates rise or unemployment does
But this sweet spot is ending. Mortgage rates are as low as they'll ever get. Meanwhile the cost of living is rising again as sterling tanks.

The reality is that interest rates - and thus the cost of mortgages - can go nowhere but up from here. On the one hand, if this is a genuine economic recovery, inflation will start to become a problem, and the Bank of England will have to raise interest rates. And if it's not a genuine recovery, things could get even worse.

The trouble is, the banks have quite a nasty deadline coming up: to replace funding from the wholesale market (where banks borrow from each other and other institutions), which dried up after the credit crunch (that's why Northern Rock blew up). So the Bank of England has effectively pumped about £300 billion into the mortgage market.

The banks will have to start paying that back from next year onwards and Mervyn King has warned there will be no extension. Unfortunately for the banks, the wholesale market is unlikely to have reopened for that kind of money by then. If they can't close that 'funding gap' somehow, they simply won't be able to lend as much, which will drive up mortgage rates.

On top of that, stricter regulations on capital (ie, banks will have to hold more money against the loans they make) and continued growth in bad debts, will make banks warier of lending money to consumers.

One way or another, higher interest rates are coming and with house prices still chronically over-valued in this country (by nearly 30% compared to rental prices, reckons The Economist), another crash is inevitable. January 2010 may not mark the beginning, but it's certainly a warning sign of things to come.