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New lending restrictions are not the answer to rising house prices

In a move which has been telegraphed for some weeks the Governor of the Bank of England, Mark Carney, has just revealed proposals to cut riskier mortgage lending. They are

  • a new affordability test : mortgage lenders will have to assess whether borrowers could still afford their mortgage if Bank Rate rose 3% higher than at the beginning of the loan.
  • a cap on the level of high-risk mortgages : no more than 15% of any lender’s total number of new residential mortgages should be more than 4. 5 times the borrower’s income.

At the same time the Chancellor of the Exchequer announced that no new loans at or above 4. 5 times the borrower’s income will now be available under the government’s Help to Buy mortgage guarantee scheme.

As house prices have increased dramatically in some parts of the UK there has been rising concern that an expected rise in the bank lending rate could lead to another crash.

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Fears about rising levels of mortgage borrowing

The Bank of England cannot control house prices, nor can it address underlying structural issues related to the supply of houses. Its role is to manage risks to financial stability including the build-up of unsustainable levels of debt.

It is therefore concerned that rising levels of mortgage borrowing are creating a potential risk to the financial and economic stability of the country as a whole.

Mortgages are the single largest liability of UK households, representing 80% of household debt. If borrowers find themselves in financial difficulties this will in turn have a negative effect on the banks and other mortgage lenders, and on the economy as a whole.

Consequently the Bank believes that action is needed now to prevent this problem arising in the future.

In his statement on the proposals by the Bank’s Financial Policy Committee (FPC) Governor Mark Carney said   

“The FPC does not believe that household indebtedness poses an imminent threat to stability. Underwriting standards are more responsible than they were in the past. However, we have seen time and again how quickly responsible can turn to reckless, creating risks that ultimately derail the UK economy. The FPC is concerned that a marked loosening in underwriting standards and an associated significant increase in the number of highly indebted households could pose major direct and indirect risks in future. So we are taking action today to prevent this from happening”

New restrictions not expected to have much impact outside London

The Bank does not expect these measures to have an immediate negative effect on mortgage borrowing. The current share of new mortgage lending with Loan-to-Income ratio in excess of 4. 5 is around 10%, while the recommendation on affordability tests is in line with the current practice of prudent lenders.

In fact the Banks proposals do not go far enough for some politicians. Vince Cable for example has been calling for a much lower cap on high Loan-to-Income lending.

But as the Council of Mortgage Lenders has pointed out “Limiting the level of a lender’s lending to no more than 15% of new mortgages at 4. 5 times income or above (and none at all for Help to Buy guaranteed loans) is likely to impact the London market more than elsewhere. Nationally, 9% of new loans are at 4. 5 times income or more, but the figure is 19% in London. ”

It also seems that the increased affordability tests for borrowers which were introduced recently have already caused a slowdown in the number of mortgage applications.

It is arguable whether house prices across the country as a whole are rising as fast as some people make out. Headline figures often just relate to central London, but in much of the country there is little evidence that prices are out of control.

Don’t cap the money supply – get more houses built

Capping the money supply for mortgages may be a quick and easy solution to the apparent problem.

But it is abundantly clear is that the real reason for rising house prices is the shortage of houses available to buy. It seems that existing owners are staying put and agents report fewer properties are coming on to the market.

At the same the number of new homes being built has declined because of the recession. Although builders are now working hard to build more homes the fact is that the number being completed will be well below the number estimated to be required for some years to come.

That is the real problem which must be addressed by the government if it really wants to stop house prices rising too fast.

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