While highly geared lending might seem safer than it was now that the economy is picking up speed, the fact that it is recovering means that the point at which interest rates begin to rise moves closer. It is the most highly geared borrowers that are most vulnerable to rising rates, so a decision to limit lending to this sector seems prudent.
Setting a limit for the policy at over £500,000 also means that the banking group effectively chokes off demand for highly geared lending in London, as this level of borrowing is much rarer outside the capital. Indeed, a loan-to-income ratio of four at £500,000 implies a household income of £125,000. That is high, given that the combined mean gross average earnings of a male and female working full time in London is about £87,000. So the policy will only hit those at the higher end of the price distribution rather than the mainstream market.
The £500,000 borrowing limit means that on its own it is perhaps less of a restrictive policy than it may have first appeared. Based on average prices, only four of London’s 33 boroughs would be constrained by the policy – Camden, Hammersmith and Fulham, Kensington and Chelsea and Westminster. Others, namely Wandsworth, Hackney, Richmond and Islington, are close to the limit.
That does not mean that these sectors of the market will collapse, but it will slow price growth as those who really want to buy have to share more of the risk by putting in more of their own capital – another way of proving sustainable affordability. Of course LBG, while large, is not the only lender, so the effect on actual lending in the market will depend on the stance others take, and the exposures in their own lending books. But the move will undoubtedly send a message to the market as a whole.
That message is on top of those sent out by the Bank of England about the powers it has up its sleeve to cool price growth. BoE governor Mark Carney has mentioned the loan-to-income ratio several times and the Financial Policy Committee has already adopted the power to raise the level of interest rates lenders use in their affordability stress tests. The next meeting of the committee is on 17 June and it could decide to adopt more macro prudential powers to target lending in the areas where house-price growth is frothiest.
Adopting powers does not mean they will be used, of course, but it sends out a strong message – one that is clear to buyers and sellers, too, and should drive behaviour that will help improve the health of the overall market.
First, if the effect of tightening criteria helps to moderate expectations, not only will it cool the pace of price growth, but it will also lead to more badly needed supply coming
to the market as sellers begin to accept that prices are unlikely to continue rising at such a pace.
There are already signs that there is some slowing in the pace of price growth in the capital, especially at the highest prices where it has been strongest. Hamptons International data shows that the average price of homes sold is coming down, illustrating the increased relative proportion of activity in the lower-priced bands.