The new affordability stress tests introduced by the Bank of England in June were designed to ensure financial stability rather than to control the property market and subdue house price growth.

However, building on the regulatory changes set up by the Mortgage Market Review (MMR), the Bank’s latest set of measures look increasingly likely to rein in the more bubbly parts of the housing market and to curtail the growing number of first-time buyers.

Under the new rules brought in by the Bank’s Financial Policy Committee (FPC), lenders are required to assess whether borrowers could still afford their mortgages if, at any point over the first five years of the loan, rates were to be three percentage points higher than the rate at origination.

Mortgage lenders are also required to limit the proportion of mortgages at 4.5 times income or above to no more than 15% of their new mortgages. These latest changes are far more prescriptive than the tighter lending rules introduced by the MMR in April, which required stress tests but did not set a rate.

Furthermore, the UK banking sector is currently undertaking a particularly stringent collective stress test, which examines the resilience of banks should house prices fall by around 35%. The exercise is to be completed by the end of the year.

Market impact

It is still too early to truly assess the full impact of these measures on the housing market. The current available data reflects the market prior to the FPC announcement, leading to some confusion over the direction of the market.

Some commentators argue that some of the weaker data recently released reflect a temporary reaction to the new mortgage rules brought in by the mortgage review. Figures from the Council of Mortgage Lenders (CML) showing that the number of loans advanced to first-time buyers rose by 9% between April and May, could support that view.

Click Graph 2.1 below to enlarge

However, as we touched on in our lead article, other data suggest that the market could be cooling already.

Although the number of homes changing hands remains higher than this time last year, the HMRC estimates that the number of seasonally adjusted residential property transactions decreased by 3.5% between April and May. In fact, there has been a gradual decrease in the number of transactions since February, following particularly strong winter months.

Separate data from Hometrack suggest a fall in the percentage of postcodes showing monthly price increases, falling from 42% in May to 24% in July. In London that figure is as low as 12%, only marginally higher than the proportion of postcodes showing a price fall.

Stretched borrowers

The Bank of England’s Financial Stability Report which accompanied the FPC’s announcement in June, highlights growing debt levels among some households.

The proportion of borrowers taking out Loan to Income (LTI) multiples greater than 4.5 rose to almost 11% in the three months to March 2014 compared with just under 9% last year and an average of 6.3% in the pre-downturn period of 2005-07.

Unsurprisingly, LTI multiples are particularly high among those buying higher value properties with mortgage debt, especially in London. Almost 17% of buyers spending over £300,000 were borrowing more than 4.5 times income. One in five new mortgages in the capital were above this multiplier, over twice the UK average.

However, across the market as a whole the Bank expects the share of new mortgages at LTIs at or above 4.5 to be within the newly imposed limit. So, while the cap will not affect lending on a national level, it does highlight the higher levels of borrowing in the capital and hence where banks are likely to tighten their lending to reduce their risk exposure.

Click the Graph 2.2 below to enlarge

Further tightening?

Stretched first-time buyers are also spreading their debt over a longer term. The Bank’s report shows the average length of a mortgage among those borrowing 4.5 times or more is now 30.5 years compared with 26 years for those borrowing between 2 and 3 times incomes.

While alive to the issue so far, the FPC has articulated no plans to attempt to reduce mortgage length. But should there be further need to tighten lending, this is a possibility.

Restricting mortgage lending will inevitably exclude greater numbers of first-time buyers who will face greater barriers to homeownership.

As a result the number of people able to participate in the property market is set to fall, reducing demand among buyers but increasing the need for more rental homes.

Taken from
Residential Property Focus Q3 2014