Safer mortgages mean lower house prices!

Proposed tighter rules could lead to another collapse in mortgage lending and house prices.

After a lengthy investigation into the UK mortgage market, the Financial Services Authority (FSA) issued its latest Mortgage Market Review in July.

The Mortgage Market Review (MMR) is the FSA’s latest shot at ending lending excesses, such as the huge credit boom which ended with the housing crash of 2007/09. In the words of the City regulator, the MMR is its attempt to ‘make sure all borrowers with a new mortgage can afford it’.

However, those three little letters -- MMR -- have caused panic among property professionals and pundits, much in the same way that MMR vaccines (for measles, mumps and rubella) caused a medical scare in the Nineties.

Indeed, mortgage lenders, estate agents, surveyors and other property insiders are up in arms about the FSA’s attempt to make mortgage lending more responsible.

Responsible lending in a nutshell

To me, what the FSA is trying to do is, in itself, eminently sensible. By curbing reckless and predatory lending, the FSA hopes to create a more stable, sensible and well-managed mortgage market. In addition, this should lead to a safer and more secure housing market.

Here’s a summary of the FSA’s proposed rules for future lending. Lenders should:

• insist on documentary proof of income (thus killing off self-certification or ‘liar loans’);
• assess affordability (of mortgage repayments) by comparing income and expenditure;
• assess affordability on a repayment (capital and interest) basis, even for interest-only loans;
• for applicants with impaired credit histories, apply an extra buffer to the affordability test;
• apply an interest-rate stress test, to check that borrowers can continue to meet repayments when rates rise; and
• assume a maximum loan term of 25 years, even if the loan actually last longer.

Taken as a whole, these proposals should be welcomed. For example, with only 13% of the UK workforce self-employed, why did lenders allow unverified self-cert mortgages to account for 43% of new lending in the first quarter of this year? Lenders should not hand over, say, a six-figure sum to a borrower on a mere ‘nod and a wink’!

Here come the criticisms

By attempting to curb reckless lending and take the mortgage market back to basics, the FSA has attracted a lot of flak, most notably from the Council of Mortgage Lenders (CML), the trade body for mortgage lenders.

The CML’s members undertake 94% of UK residential mortgage lending and have 11.4 million mortgages worth over £1.2 trillion. Hence, any major changes to the rules governing mortgages will hit CML members hardest.

According to the CML, had the FSA’s new rules been in force between April 2005 and March 2009, around 3.8 million ‘good’ loans would have been rejected. In other words, over half (51%) of all loans would have been declined during these four years.

In recent weeks, the CML has also got its knickers tightly twisted over the FSA’s proposed rules governing interest-only mortgages. Interest-only mortgages offer lower monthly repayments than repayment loans, but do not offer the same certainty of repayment.

At their 2007 peak, interest-only loans accounted for 34% of all mortgages (still well below their all-time peak of 83% in 1988). This meant that one in three borrowers relied on future house-price rises or uncertain life events (such as downsizing) to repay their debt.

Hence, mortgage lenders need to take extra steps to protect borrowers with interest-only loans. In particular, the FSA wants lenders to check each year that interest-only borrowers have suitable repayment vehicles in place, leading to significant extra compliance costs for lenders.

One trade body, the Intermediary Mortgage Lenders Association, claims that interest-only loans would become ‘effectively obsolete’ were the FSA’s restrictions to be imposed.

What about the future?

According to the FSA’s own projections, the CML is crying wolf. The regulator argues that, had the MMR rules been introduced in 2005, only one in six loans granted (17%) would not have gone though. This is a mere third of the 51% rejection rate which the CML calculated.

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Nevertheless, the adoption of the new MMR rules would undoubtedly lead to fewer mortgages being approved and lower levels of mortgage lending. Indeed, with risky lending largely restrained, applicants on the fringes of affordability -- including first-time buyers, the self-employed, and other non-standard borrowers -- could be turned away in droves.

What’s more, any restrictions on future lending are sure to lead to lower demand from would-be owner-occupiers in future. While this is likely to lead to a more stable housing market and less severe market crashes, it will inevitably mean lower house-price inflation than we’ve seen in the past. In a world of black-and-white lending, ‘grey’ borrowers are going to lose out.

Finally, the FSA’s Mortgage Market Review consultation period ends in November, so watch this space for news of the next steps in this ongoing war between the regulator and the regulated...

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