Published: 22 February 2016 | Author: Bob Pannell
- Our data shows that mortgage repayment terms are continuing to get longer. Nearly 60% of first-time buyers now take out a loan lasting for more than 25 years.
- The trend towards borrowing over longer terms also extends to movers and those remortgaging.
- Although pension freedoms and the fact that we are living longer will be influences, the main reason for lengthening terms appears to be related to borrowers stretching their incomes to get on the housing ladder.
- There are other ways of coping with affordability problems, including borrowing at higher income multiples. But when the Financial Policy Committee introduced new limits on this, there was an immediate lessening of lender appetite to advance mortgages at higher income multiples.
A potential problem is building under the noses of Financial Policy Committee (FPC) policy-makers, and it has nothing to do with buy-to-let lending.
Back in June 2014, the macro-prudential regulator announced housing tools in the regulated part of the mortgage market. For those with short memories, there were two measures: lenders should check that borrowers could afford their mortgage payments if bank rate moved 3% higher during the first five years; lenders should also restrict their new lending such that no more than 15% was at income multiples of 4.5 or more (“high” income multiples).
The FPC presented the intervention as a forward-looking measure, designed to insure against the perceived upside risks to financial stability that could arise from household indebtedness, by bearing down on the ability of households to take on potentially onerous commitments.
At the time, mortgage lenders were already stressing affordability broadly in line with the Bank’s recommendation, and so the main thrust of the intervention was to limit upward income stretch.
Chart 1: Income multiples >=4.5, % take-up by borrower type
Although the measure did not take effect for several months, Chart 1 shows that there was an immediate lessening of lenders’ appetite to lend at high income multiples.
This may have been a surprise for the macro-prudential regulator, as it had not expected its tools to have a material impact on mortgage lending and housing transactions in the near term.
After peaking at 10% just ahead of the FPC action in mid-2014, the proportion of high income multiple lending eased back considerably over the following year, to just below 7%.
But the picture has changed a lot over the past six months or so.
The incidence of high income multiple lending has increased sharply, especially for movers, and retraced a good chunk of the previous year’s reduction.
According to our estimates, one of the FPC’s core indicators (shown in Annex 2 of its Financial Stability Report) is now showing that income multiples are within a whisker of their mid-2014 peak.
So what is happening?
To some extent, there may have been something of a precautionary 'knee-jerk' response from lenders to the new housing tools when they were first announced, and we are now seeing that unwind as lenders become more adept at working within the FPC’s strictures.
While this would square with a pick-up in the proportion of lending at or above 4.5 times income, there has, in fact, been a much broader increase in higher income multiples over recent months. Several metrics suggest that borrowers are now stretching their incomes more than in mid-2014.
Chart 2: Lending at higher income multiples, % of all regulated lending
Mounting affordability pressures, as house prices outpace earnings growth across much of the UK, provide the most plausible explanation for the change of direction.
Lengthening payment terms provide strong evidence that such pressures are intensifying. Although the use of longer terms varies greatly across different types of borrower, reflecting their respective age profiles, the underlying trend is clear.
Among first-time buyers, the proportion of borrowers taking out loans with a maturity of more than 25 years has continued to increase and now accounts for nearly 60% of the total, roughly double that of a decade ago.
The median term for first-time buyers has, in fact, lengthened from 25 to 30 years within just a few years. Although greater pension freedoms and the fact that we are living longer will be influences, the quantum nature of the shift suggests that it is mainly to do with stretching incomes to get on the housing ladder.
Chart 3: Repayment terms longer than 25 years, % take-up by borrower type
As we wrote in late 2014, lengthening payment terms simply reflect the affordability 'facts of life' for many mortgage borrowers.
If the impact is now showing through as upwards pressure on income multiples, then the FPC’s 15% limit risks becoming a progressively harder cap over time, and we should expect to see a build-up of lending just below the 4.5 times threshold.
Looking forward, the macro-prudential tools may help the housing market to cool. But, if house price pressures persist, then the FPC may find itself subject to much closer public scrutiny, as it exerts a more visible effect on the pace of housing activity and generates headwinds to the government’s pro home-ownership policies.
What an interesting time for the regulator to be considering interventions in the buy-to-let space!