Mortgage lender Abbey now allows homebuyers to borrow up to five times their salary. This will prove to be a huge mistake...
Abbey, which is the UK's second-largest mortgage lender and is now owned by Spanish bank Banco Santander, has laid down the gauntlet to other mortgage lenders.
Lending money to homebuyers and homemovers is a cut-throat market, with more than a hundred different lenders competing for mortgage business, and over eight thousand different home loans on offer.
In order to try to win more business, particularly from first-time buyers, Abbey is now willing to lend single or joint borrowers five times their combined yearly incomes before tax. Traditionally, mortgage lenders would be willing to lend at most 3½ times income. Hence, by offering five-times-salary mortgages, Abbey is willing to lend three-sevenths (43%) more than it did in the past.
Abbey claims that only borrowers with good credit histories and low levels of non-mortgage debt would be able to borrow five times their incomes. However, at the same time, it has reduced the deposits which it requires borrowers to stump up, and loosened its criteria for self-certification mortgages (those which don't require proof of income).
On the plus side, only a minority of borrowers will qualify for one of these "superstretch" mortgages, as they must have an annual income before tax of at least £60,000 and a minimum deposit of 3% of the purchase price. According to the Office for National Statistics, only a tenth (10%) of the workforce earns more than £40,544 a year, so Abbey won't find many individuals wealthy enough to take on this mortgage on their own. Then again, two or more borrowers can club together to grab one of these mortgages, which would be very dangerous indeed, in my opinion!
Of course, being able to borrow 43% more doesn't necessarily mean that you should do so, because taking on 43% more debt means taking on far more than 43% extra risk. Nevertheless, with the average house now costing three times as much as it did as a decade ago, there will be a queue of borrowers waiting to mortgage themselves up to the hilt in order to buy their dream home. There's also no doubt in my mind that other lenders will follow Abbey's lead, in order to maintain their market shares.
In fact, Abbey is by no means the only mortgage lender willing to stretch affordability to the absolute limit. Bank of Ireland Mortgages and Bristol & West will lend 4½ times income; Royal Bank of Scotland and Cheltenham & Gloucester also stretch to five times income; Northern Rock extends to nearly six times income; and Advantage from Morgan Stanley will push the boat out to a seriously risky six times income. Yikes!
But what happens when the dream turns into a nightmare? When the Bank of England raises its base rate (which it is almost certain to do later this month and perhaps again early next year), variable-rate mortgages will rise accordingly. For many borrowers, an extra half-a-percentage point on their variable-rate mortgages will take their household finances into dangerous territory.
For example, let's look at the situation of a couple who earn £60,000 a year between them and borrow £300,000 on an interest-only basis from Abbey. Furthermore, let's assume that they're paying a variable interest rate which matches the Bank of England's base rate. At present, they'd pay yearly interest of £14,250, but if the base rate rises by 0.5%, their interest bill would increase by £1,500 to £15,750 a year. Paying £125 a month extra interest would put a big dent in anyone's household budget, especially people who are as overstretched as this!
Abbey's latest move smacks of desperation to me -- and reminds me of the mortgage madness which reigned at the end of the Eighties, just before the last housing crash! Indeed, in my working life, I've seen what happens to individuals and families who borrow more than they can comfortably afford to repay. Sadly, I've been in court on a number of occasions watching as severely stretched homeowners lost the roofs over their heads when they could no longer service their mortgages.
This is something which affected me profoundly, which is why I'm extremely worried about record levels of insolvencies and bankruptcies. Despite the UK enjoying thirteen years of unbroken economic growth, individuals are going bust at record rates. Indeed, insolvencies and bankruptcies will easily exceed 100,000 this year -- a figure far bigger than any recorded during the last bankruptcy boom in the recession of the early Nineties.
To be frank, I feel sorry for first-time buyers who are priced out of the market, and those struggling to climb another rung on the housing ladder. The growth in house prices has massively exceeded wage increases, which has made buying a home more expensive now than at any time since the Industrial Revolution in the nineteenth century. Nevertheless, I would urge these people to avoid taking on an overwhelming debt in order to become a property owner. To me, the risks outweigh the rewards -- especially as house prices cannot and will not keep going up faster than wages forever.
Finally, if you need help with navigating the mortgage maze, I recommend that you give the Fool's Mortgage Service a whirl. It's run by award-winning, no-fee mortgage broker London & Country mortgages, and gives you access to the whole mortgage market plus exclusive deals from L&C. Just don't borrow five times your income, please!
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