Bank of England’s new powers could make things harder for first-time buyers

David Kingman analyses the decision to grant the Bank of England new powers to curb high loan-to-income mortgages, and what they could mean for first-time buyersHousing interest rates

The Bank of England is to be given new powers to limit the proportion of high loan-to-income mortgages that banks are allowed to lend, Chancellor George Osborne announced during his annual Mansion House speech on 12 June.

This move has been designed to help take some of the heat out of the housing market, although the upshot could be that it makes it more difficult for would-be first-time buyers to get on the housing ladder.

A modest proposal

Now that Britain’s economy is growing again, pressure is rising for the Bank of England to finally raise interest rates in order to prevent inflation. The Bank’s governor, Mark Carney, used his own speech at the Mansion House event to hint that he may raise rates later this year.

However, there appears to be a growing concern among policy-makers that rising interest rates could pose a new threat to the economy. As a result of Britain’s high house prices, many borrowers have had to take out very large mortgages in order to get on the housing ladder over recent years. Low interest rates have made this affordable, but a rate rise could potentially pull large numbers of overextended borrowers under water, dragging the banks down with them.

In his speech, George Osborne argued that Britain needed to be on guard against this threat: “Does the housing market pose an immediate threat to financial stability today? No, it doesn’t. Could it in the future? Yes, it could, especially if we don’t learn the lessons of the past. So we act now to insure ourselves against future problems before they can materialise.”

This chimed with the findings of a recent IMF review of Britain’s economy, which warned that: “House price inflation is particularly high in London, and is becoming more widespread. So far, there are few of the typical signs of a credit-led bubble. Nonetheless, a steady increase in the size of new mortgages compared with borrower incomes suggests that households are gradually becoming more vulnerable to income and interest rate shocks.”

So what is George Osborne proposing to do? Given the scale of the potential problem, his policy prescription was actually relatively modest. The Bank of England’s Financial Policy Committee (FPC) already has the power to recommend that banks should limit high loan-to-income mortgages to below a certain proportion of their overall lending (to reduce their exposure to overextended borrowers), but the Chancellor proposed that this should evolve into the power to force banks to do so. He even suggested that the FPC should be able to set a ceiling for a ratio between a borrower’s income and the size of their mortgage, although critics were quick to point out that this would need to be implemented in a manner which was sensitive to the regional differences in Britain’s housing market.

An idea to build on?

The initial response to George Osborne’s policy announcement was fairly mild, with representatives from the Council for Mortgage Lenders arguing that other measures – including the new affordability tests which borrowers have to pass before they can be approved, and the tougher requirements on capital limits – have already done a lot to reduce the threat posed by overextended borrowers.

This is good news from the point of view of the overall stability of the economy, but it leaves a much bigger question unanswered.

Why is next to nothing being done to address the root cause of this problem, which is high house prices? A main explanation why so many borrowers, especially first-time borrowers – who are likely to find it more difficult to get on the housing ladder if access to mortgages becomes increasingly restricted – have become overextended in the first place is because house prices are too high relative to incomes.

According to the ONS House Price Index, the ratio of house prices to earnings for the typical first-time buyer had increased from 2.5 times in 1969 to almost 4.5 times in 2012. Making it tougher for banks to lend to would-be borrowers can only be a sticking plaster solution at best, or as the IMF warned in the findings of their economic review quoted above:

“Macroprudential and monetary policies can only be temporary palliatives to an underlying problem… fundamentally, house prices are rising because demand outstrips supply.”

To his credit, George Osborne did announce plans to create an additional 200,000 new homes alongside giving the Bank new powers, but that is nowhere near the level of new construction needed to deal with current demand. Politicians are often accused of being afraid to take on the interests of influential NIMBY voters, but unless we build more houses, more and more of us will have to take on unsustainable levels of debt if we want to get on the property ladder – an outcome which is in nobody’s real interests, least of all the government’s.