It is just over a year since the Bank of England’s Financial Policy Committee (FPC) imposed a loan-to-income (LTI) cap on lenders, specifying that no more than 15 per cent of their total lending should be above 4.5 times income. In recent months individual lenders have been adjusting their LTIs both up and down, and sometimes more than once.
He also believes that the market is moving into a phase where lenders are looking around and asking who has been more relaxed with implementation and who has been too tough in the course they have taken. “Obviously, some approaches favour certain types of borrowers more than other approaches, and lenders are asking themselves if they’ve taken too hard an approach,” he says.
Many lenders adjusted their LTIs before the October deadline while Barclays has probably made the most revisions to its LTIs since the FPC’s ruling, taking a tiered approach – presumably in a bid to better shape and control the kind of business it is getting. We are likely to continue hearing about changes to lenders’ LTIs for some time as they are having to learn as they go along.
In June 2014, the BoE documented the risks to the resilience of the banking system and to economic stability posed by high levels of household indebtedness. In a bid to counter the risks, it announced that lenders should apply an interest rate stress test on borrowers’ income as well as the LTI cap.
In its June 2015 Financial Stability Report, the BoE states the household debt to income ratio has plateaued as the housing market has slowed.
Table 1 shows the LTI ratios for new mortgages since 2011 and three-year projected figures. The Bank believes that its recommendations have had a small impact, concluding that the threat to stability remains and that the recommendations remain warranted. Now it is threatening to take a similar approach to the buy-to-let sector, again for fear of the potential risk to stability that it believes the sector poses.
Income stretch
The problem is, in a market of high house prices, borrowers are looking for higher income multiples to enable them to reach for that next step on the housing ladder. Especially in popular areas such as London and much of the south east where high prices mean there is a demand for this type of borrowing. While the LTI cap affects everyone, there are two main groups of borrowers specifically affected – those who can easily afford higher LTIs and those at the other end of the spectrum.
As Mr Hollingworth points out, the introduction of the MMR with its emphasis on affordability means that the market has moved away from the ‘one size fits all’ mentality of income multiples. “Income and outgoings are a core plank of MMR and are now firmly in place in the UK mortgage market” he says.
But if the emphasis is now on affordability, why should borrowers who can clearly afford to pay for a mortgage way above the 4.5 times income cap be restricted? Perhaps for borrowers who can afford such income multiples there will always be options. Of course, the direction for lenders’ LTIs is not just one way – cherry-picking specific borrowers has never gone out of fashion.
The BoE says that, in response to the restrictions, some borrowers switched lenders but some also settled for lower LTIs. As for lower income borrowers, such as younger and typically first time borrowers, it simply adds to the obstacles preventing them from stepping on to the housing ladder. However, while such borrowers will try to stretch themselves, they recognise that the most important thing is to prove that they can afford the loan.
Blanket cap
Some advisers have expressed fears that lenders might simply impose a blanket cap across the board leaving little differentiation between them. So far, however, that does not appear to be happening. In October this year, West Bromwich increased its maximum LTI on a tiered basis, while NatWest cut its LTIs on some loans. In August, Barclays reduced the threshold at which its maximum LTI applies, having already made adjustments in March and June this year. Ultimately, a blanket cap could mean that the whole premise of affordability, which the MMR has spent so much time trying to embed, would be completely undermined.
There have been calls for the BoE to put a time limit on the cap, lest it dampen the market too much. Mr Hollingworth says that when it was first imposed the market was seen as too “frothy”. Since then, however, things have calmed down. Whether that could be attributed to the LTI cap or the fact that things would naturally calm down after the MMR rules were introduced is very hard to tell. “It could be argued that this proportionate approach has worked,” he says.
