The government has sent out a rallying cry in all directions in its drive for growth. The Financial Conduct Authority (FCA) has answered, and is considering how it might loosen mortgage regulation to support homeownership and ultimately boost the economy.
Changes under consideration are believed to include increasing the 15% loan-to-income ratio (LTI) cap on lending.
The IMLA has long been calling for this change, and we would welcome a greater degree of flexibility in the regulator’s approach, with the ultimate aim of benefitting more borrowers.
Increasing the LTI limit – or scrapping the mandatory maximum and allowing lenders to set their own boundaries within their own credit risk parameters – would be a good place to start.
Giving lenders more autonomy
The LTI limit is a Financial Policy Committee (FPC) rule, which restricts lending at or above four-and-a-half times income to no more than 15% of mortgage lenders’ advances if they lend more than £100m per year.
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The 15% proportion is arbitrary – there is no convincing rationale for the number itself. As a blanket figure applied to all but the very smallest lenders, it is also an imprecise measure that cannot take into account the huge variety in the financial profile of different banks, building societies and non-bank lenders.
Further, in reality, most lenders do not get close to the 15% limit, since exceeding it would attract regulatory (financial) sanctions: most will start putting the brakes on as soon as they approach around 11% of total advances, in order to leave themselves some headroom.
If the 15% limit were deemed to have some credible justification, then it would make sense for the target or limit to be set higher – perhaps at 20%.
Opening the market up to ‘high-risk’ borrowers
The low limit distorts the market to the particular detriment of first-time buyers, single purchasers and those on moderate incomes, because the limit has a rationing effect on lenders’ funding, encouraging them to prioritise lower-risk customers and larger mortgages above the limit.
Almost all single first-time buyers and many couples need to borrow more than four-and-a-half times their income in order to become homeowners, given that the average house price to income ratio in the UK is 8:1.
That is why most lenders will offer higher income multiples to those who qualify, assuming they have passed stringent affordability tests, which typically check that the borrower can still afford to make their monthly repayments at a rate at least 1% above the lender’s own standard variable rate (SVR) on any product shorter than a five-year fix.
This is an important point. In advocating the removal of mandatory LTI limits, lenders are not asking for the freedom to lend irresponsibly – that is in neither the borrower’s nor the lender’s interests – but simply to lend to larger numbers of borrowers who have already demonstrated that they can comfortably afford to repay the mortgage in question.
Shutting out first-time buyers
It is difficult to measure the precise impact the LTI limit has had on the landscape, but it may well have contributed to the 3.1 million shortfall in first-time buyer numbers since the 2008 financial crisis, revealed in our own mortgage affordability paradox report last year.
IMLA’s research revealed that, despite strong affordability during the ultra-low interest rate years from 2013 to 2022, first-time buyer numbers failed to pick up to the level previous trends would have suggested.
Over the last 40 years, two periods have provided excellent affordability, with mortgage repayments taking up less than 30% of a first-time buyer’s income: 1993-2003 and 2013-22. In the first period, first-time buyer numbers averaged 500,000 per year. In the second, the figure was just 330,000 – hence the 3.1 million shortfall over the nine-year time period in question.
One possible explanation for the muted resurgence in first-time buyer numbers in 2013-22, despite excellent affordability, is the wide-ranging regulation that was put in place in response to the financial crisis, notably the LTI flow limits, combined with higher capital requirements on high-LTV lending.
The societal benefits of homeownership
Capital requirements are perhaps a discussion for another article. But the limits on higher LTI lending are clearly a barrier to homeownership, forcing more people to remain in rented accommodation for longer and delaying or forgoing the well-researched benefits that homeownership brings: security of tenure, better mental and physical health, the opportunity to build up significant capital value and to release some of that equity, if necessary, in times of economic hardship.
Barriers to homeownership risk the creation of a large group of less financially stable households over the medium to longer term, particularly as these households often move into retirement without the resources to pay private sector rents and with no equity to fall back on – a large group very likely to need housing funded by the state.
In short, homeownership is good for people, good for their own wealth and good for the nation’s balance sheet. Boosting first-time buyer numbers fuels the fire in the engine room of the UK housing market, which feeds the construction industry. It also heats up demand for white goods, soft furnishings and DIY paraphernalia.
It creates more work for valuers, conveyancers and mortgage intermediaries, all of which sounds suspiciously like growth.
The logical case for scrapping LTI limits has been obvious for some time. The political rationale may have just arrived.
