Should mortgages be restricted by income?
The Turner Report, published by the Financial Services Authority (FSA) in March, into how Britain should respond to the global economic crisis poses several questions about the UK mortgage market - including whether loans should be restricted by income multiples.
If mortgages were limited to three times a borrower’s income, would it stop people running into difficulties making payments? Or is just looking at income, as opposed to overall affordability, too simplistic?
Katy John, spokeswoman for PricedOut.org.uk, a website campaigning for affordable house prices, believes mortgages should be restricted to income multiples:
PricedOut supports the restriction of loans based on a person’s income. Over the last 10 years we’ve witnessed potentially the most destructive housing bubble in history. Irresponsible lending was one of the key factors in driving UK house prices up to their peak of almost six times the average salary.
If loans are restricted to three times a person’s income, prospective homeowners might be affected in the short term. But first-time buyers have long been telling us that what would really benefit them is a fall in house prices to affordable levels. Regulating mortgage lending will help to achieve this. Those opposing greater mortgage regulation tend to be those with a vested financial interest in keeping house prices high.
A failure to regulate mortgage lending has fuelled the perception of properties as assets to be viewed as stocks and shares rather than as homes. It has introduced a much greater level of risk into the housing market, threatening many people’s livelihoods.
For instance, the number of repossessions is expected to soar to 75,000 in 2009. A more sensible approach to lending would have prevented the disastrous consequences that many people are now facing and helped Gordon Brown to keep the promise he made in 1997 when he said “I will not let house prices get out of control”.
Reassuringly, almost two-fifths of prospective first-time buyers are now increasing the rate at which they save towards a deposit, in the wake of house prices returning to affordable levels.
Even if they have to save a larger deposit as a result of mortgage regulation, doesn’t it paint a more promising picture to think that this generation of young people might now be able to achieve what was fast becoming just a pipe dream: the security of owning their own home?
Ray Boulger, senior technical manager at mortgage broker John Charcol, believes overall affordability is a better measure for mortgage lenders to use:
The Turner Report called for a debate on income multiples but recognised that by limiting income multiples the “democratisation of home ownership will be adversely affected”, meaning this policy would discriminate against those on lower incomes.
It could even be illegal; anti-discrimination legislation could be used to prosecute a company whose policy had the effect of discriminating against a section of the community – in this case, the low paid.
A one-size-fits-all maximum income multiple would particularly hurt first-time-buyers as they tend to borrow an above-average multiple, because they’re usually at an age when they can expect to be awarded above-average salary increases. Borrowers should be free to choose the proportion of income they allocate to their home.
The FSA has previously encouraged lenders to use ‘affordability’ instead of strict income multiples as the basis for deciding how much to lend, and all the major lenders have adopted this approach. Reverting to old-fashioned income multiples would be a seriously retrograde step.
There are lots of factors other than income to take into account when deciding how big a mortgage is affordable.
These include interest rates (both current and likely future rates); whether the rate is variable, and a short-term or a long-term fix; whether it’s a single or joint application; the number of dependents; other financial commitments such as loans, credit cards and
maintenance payments; and the amount of income a person has – someone on a high income can afford a bigger multiple than someone on a low one, as a smaller proportion of income is needed for other necessities.
The Financial Services Authority is an independent non-governmental body, given a wide range of rule-making, investigatory and enforcement powers in order to meet its four statutory objectives: market confidence (maintaining confidence in the UK financial system), financial stability, consumer protection and the reduction of financial crime. The FSA receives no government funding and is funded entirely by the firms it regulates, but is accountable to the Treasury and, ultimately, parliament.