If the Government restricts mortgage lending to three times income, it could be the straw that finally breaks the housing market's back.
The Government announced today that it is conducting a review of mortgage lending that may stop you from borrowing more than three times your income.
It plans to assess the strength of arguments for and against limiting lenders to traditional, low income multiples, and report back in September.
Traditional income multiples were three times single income or two and a half times joint income, for many years, but in recent years this method of deciding how much to lend has been overtaken by the use of affordability criteria (where the lender looks at outgoings as well as income).
And I think this is a good thing. In my opinion, restricting lending to three times a borrower's income would be a step backwards, not forwards. Here's why.
Existing borrowers
First of all, we don't know how the proposals will affect existing borrowers who borrowed more than three times their income. If the new rules are blanket across the market, then many borrowers will be left with nowhere to remortgage at the end of their deal, and could be forced to take whatever rate their existing lender is willing to offer.
Mortgage madness
Why is the Government proposing this?
Mortgage arrears have risen by 31% in the past year and the Government wants banks to go back to prudent and responsible lending. Some argue that by restricting income multiples, future arrears may be avoided and borrowers may not become overstretched.
In response, the Council of Mortgage Lenders has pointed out that the majority of arrears result from unemployment rather than the customer having over-borrowed.
However, reading various messsage boards on this topic, it is clear that many of you are in favour of the tighter criteria, citing 'responsible lending' and saying 'this should have been done years ago'.
But bear in mind that house prices have risen much faster than incomes over the past decade - even taking into account the recent falls in prices. First-time buyers today face a genuine struggle to get on the housing ladder, even those who have not overstretched themselves and are looking to buy a modest starter home. I know, because I am one. And if these rules come in I will not be able to get a mortgage that I could easily afford.
Reasons not to restrict
Of course most of us agree that lenders have been way too generous with their lending over the last 10 years, forgetting about the need for deposits and waving money at first-time buyers as property prices spiralled on upwards.
And few people think that lenders should not be more restrictive about who they lend to. But where has the FSA and Government been for the last 18 months? The mortgage market is far more restrictive than it's been for years and it is currently not that easy for anyone, let alone a first-time buyer, to get a mortgage.
First, you need to be squeaky clean and fully employed, as sub-prime and self-cert mortgages are few and far between. Then you need a chunky deposit of ideally 25% or more, and the income multiples currently being offered are not that excessive. According to the Council of Mortgage Lenders the average income multiple for first-time buyers was only three last month, down from 3.33 a year ago and the lowest level since 2005.
Plus, using income multiples to determine how much to lend to someone is a crude method the market has been gradually moving away from. And here's why:
Compare a childless couple earning £70,000 and a single mum earning £70,000 but supporting three children. Clearly the latter has far greater expenses looking after her kids and surely the former could afford to devote a bit more of their income to mortgage payments.
The same argument can be said of somebody who chooses an expensive lifestyle compared to a more frugal borrower. If one borrower has no credit card and loan debt and another has thousands in unsecured borrowing, is it really fair that they are restricted in the same way?
Of course not, and the mortgage market switched to working out maximum borrowing based on true affordabiltiy years ago. This means that as well as looking at your income they also take into account your outgoings -- such as dependents, debts, and other expenses. Moving backwards by 10 years to calculate borrowing levels on income alone has been described by one pundit as a 'retrograde step'.
Price crash
A catastrophic effect of the new measures would be to further reduce house-buying transactions and send prices further down.
Now I am all for falling prices and I believe that a necessary correction is currently occurring. But the housing market is badly damaged, many jobs depend on it and driving down prices further and faster with this measure will not help the UK economy in my view.
It's already hard enough for people to buy and making it harder could cause untold damage. Buyers will simply not be able to get mortgages large enough to buy a property, so sellers will have to drop prices, not just a bit more, but massively in order to achieve a sale.
The average first-time buyer earns about £26,000 but under the new measures would not be able to get a mortgage of more than £78,000. The average UK house price is £160,000.
This massive gap, and crude nature of the income multiple method, means I am keeping my fingers firmly crossed that the Government sees sense by September - and looks for another, more effective way to ensure prudent and responsible lending.
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