Bank of England to cap mortgage lending
The Bank of England will cap mortgage lending, limiting the multiples for new loans and remortgaging to 4.5 times income for all but 15% of new loans.
The move is in response to the fact that UK household debt is high compared to historic levels. The UK house price to average earnings ratio - something the bank referred to as a crude measure of affordability - has risen to more than six times annual earnings in the past few months, the Bank said.
While it is lower than its 2007 peak of more than seven times earnings, it's still higher than the average in the decade leading up to 2007 - when it was around five times earnings.
While some banks - such as Lloyds Banking Group and RBS - already limit their loans on properties worth £500,000 or more to an income multiple of 4, the Bank explained that with high household debt and house prices rising across much of the UK at a time of very low interest rates, households are likely to be "highly sensitive to fluctuations in property prices and sharp rises in debt-servicing costs relative to incomes".
It warned: "At higher levels of indebtedness, households are more likely to encounter payment difficulties in the face of shocks to income and interest rates. This could pose direct risks to the resilience of the UK banking system, and indirect risks via its impact on economic stability."
The Bank of England also announced that it would further the ‘stress testing' exercises mortgage lenders are currently undertaking.
They will all now have to assess a borrower's ability to repay their loan should the Bank of England Base Rate of interest rise by at least 3 percentage points, from 0.5% to 3.5%.
On average, that would take mortgage rates to between 6% and 7%. But some mortgage brokers and lenders have been stress-testing this level of potential interest rate rise for some time.
Data from the Council of Mortgage lenders suggests the effects of the income multiple cap will be felt hardest in London rather than on first-time buyers nationwide.
In the first quarter of 2014, 9% of home loans were advanced at an income multiple of 4.5 or higher, but in London that jumped to 19%. This indicates that only a small percentage of first-time buyers might lose out in the capital (if banks have already reached their 15% allocation of mortgages issued at 4.5 times salary or above). In April 2014, the average first-time buyer in the UK was granted a loan based on 3.42 times their income.
Chancellor George Osborne has also announced that there will be no more Help to Buy mortgage loans arranged at income multiples of more than 4.5.
However, while much has been written about Help to Buy contributing to rising property prices, the Bank said the direct impact of the scheme has been relatively small to date - with just over 7,000 completions up until April.
It did acknowledge that, indirectly, the scheme has increased the availability of mortgages for borrowers with a loan to value ratio greater than 90%. "The number of mortgage products available to borrowers with LTV ratios greater than 95% trebled over the year to May 2014," it said.
In reaction to the Bank of England's lending cap, some experts have said that it may delay the first rise in interest rates.
Ben Brettell, Hargreaves Lansdown's senior economist, said: "The key point is that specific action on the housing market gives the Monetary Policy Committee more freedom to leave interest rates where they are."
He explained: "There have been calls for higher interest rates to prevent house prices rising too quickly. In my view this would be a blunt instrument – the effects would be felt across the economy, not just in the housing market, and the evidence suggests the wider economy is not yet strong enough to withstand a rate rise. Wage inflation remains subdued, and the falling unemployment figures mask a fall in productivity. It therefore seems fair to assume that a significant degree of slack in the labour market remains."
He added: "Therefore despite Mark Carney's recent comments that interest rates could rise sooner than expected, I believe they will remain on hold well into next year. The Bank will want to give today's measure on the housing market time to take effect, and will want to see hard evidence that the spare capacity in the labour market has been absorbed before considering higher interest rates."
Changing mortgages without moving home. Property owners chiefly remortgage to get a better deal but some do so to release equity in their homes or to finance home improvements, the costs of which are added to the new mortgage. Even though you’re not moving house, you still need to engage solicitors, conveyancing and the new lender will require the property to be surveyed and valued.
Monetary Policy Committee
A committee designated by the Bank of England to regulate interest rates for the UK. The MPC attempts to keep the economy stable, and maintain the inflation target set by the government and aims to set rates with a view to keeping inflation at a certain level, and avoiding deflation. The MPC meets on the first Thursday of each month and discusses a variety of economics issues and constitutes nine members: the governor, the two deputy governors, the Bank’s chief economist, the executive director for markets and four external members appointed directly by the Chancellor.
An increase in the general level of prices that persists over a period of time. The inflation rate is a measure of the average change over a period, usually 12 months. If inflation is up 4%, this means the price of products and services is 4% higher than a year earlier, requiring we spend and extra 4% to buy the same things we bought 12 months ago and that any savings and investments must generate 4% (after any taxes) to keep pace with inflation. Since 2003, the Bank of England has used the consumer prices index (CPI) as its official measure of inflation (see also retail prices index).
Also referred to as the bank rate or the minimum lending rate, the Bank of England base rate is the lowest rate the Bank uses to discount bills of exchange. This affects consumers as it is used by mainstream lenders and banks as the basis for calculating interest rates on mortgages, loans and savings.
Loan to value
The LTV shows how much of a property is being financed and is also a way to tell how much equity you have in a property. The higher the LTV ratio the greater the risk for the lender, so borrowers with small deposits or not much equity in the property will be charged higher interest rates than borrowers with large deposits. The LTV ratio is calculated by dividing the loan value by the property value and then multiplying by 100. For example, a £140,000 loan on a £200,000 property is a LTV of 70%.