Loan to Income Caps – can they rein in the housing market?
Posted on 13 October 2014
The Financial Policy Committee has stepped in, with new regulations restricting lenders ability to lend mortgages that are more than 4.5 times a borrower’s income – a move which seems to impact squarely on the booming London market.
When Carney took over as Governor of the Bank of England just over 12 months ago and issued his initial “forward guidance”, there was a sense of direction despite the wave of scepticism. When unemployment fell faster than expected and Carney was put to the test; rather than increasing the interest rates, he simply retorted to using other tools to influence the market and at the end of year one, there is still no rate rise in sight. Rumours are that there won’t be one until spring 2015. (Though this decision could possibly be more influenced by the upcoming election rather than the realities of the economy).
So, what about the question of how to rein in the housing market? The market seems to rebound every time there is a regulatory change and with London house prices galloping ahead, the Governor may be worried. According to Nationwide1, the house prices jumped 0.8% month-on-month in August compared to 0.2% in July. This has forced house prices to increase from 10.6% to 11% nationally and 19.3% in London.
Compared to the earnings’ ratio, the national house prices boost represents a raise 10 times larger than the increase in earnings. In relation to London and according to a research carried by Trade Union Congress (TUC) and released in September, the house prices in most boroughs are now at least ten times the average salary. The TUC research shows that there are no longer any areas in the South of England (the South East, South West, London and the East of England) where average house prices are any less than five times the average wage.
This is particularly important as new rules from October 2014 will restrict lenders ability to lend more than 4.5 times an individual’s income. They will have to prove that no more than 15% of their total residential lending is in mortgages that are more than 4.5 times income. These new regulations build on the Mortgage Market Review implemented in April 2014. The Financial Policy Committee recommendations will affect bank and building societies with lending in excess of £100m on their books,
which in reality includes most mainstream lenders. The rules, which have become known as ‘loan-to-income caps’ (LTI’s) also affect the Help to Buy mortgage guarantee scheme and a number of lenders have started to reduce their LTI’s to 4 times income for loans above £500,000 in anticipation , starting with Lloyds Banking Group, Nat West and Accord. There is a glimmer of hope though, with a recent announcement by a smaller lender, Hinckley and Rugby, who are to increase their income multiples to
4 times salary which suggest that an unexpected side effect may be increased competitiveness and diversification among smaller lenders. It is difficult to measure what the effect will be of these new rules, as no bank exceeds the limit at present and the cap is not a binding constraint on the lenders. However, with more than 20% of London mortgages having a loan-to-income ratio of more than 4.5 times income and with an average London prices pushing to £500,000, it is clear that Londoners will be affected the most.
There are still a lot of unanswered questions such as the impact on loans to high net worth individuals where lending is based on income as well as assets. With some smaller lenders falling outside the rules at the moment as they have lending below £100m, if they find themselves doing a few larger deals for wealthy individuals, they could potentially find themselves affected by the new rules. It is obvious that the Bank of England policy on interest rates, combined with MMR and the rules around loan to income ratios are designed to manage the tricky double edged sword of maintaining economic recovery whilst managing the housing market, but will they achieve their objective? In my opinion further regulations cannot replace the need of more housing units and this is becoming an ongoing and difficult to resolve problem. Overall 2014 has been an eventful year in the mortgage market. But I have the feeling there are still more changes to come before we see interest rates increases.
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