The Bank of England (BoE) has attempted to slow the growth of house prices and mortgage lending with measures designed to stop a future credit boom.
The restrictions on large loans imposed by the bank’s Financial Policy Committee (FPC) are not currently binding, but seek to prevent lending from taking off as the economy recovers.
The BoE said it expected the effect of the FPC’s actions on the economic recovery and housing market to be “minimal” unless house prices and mortgage lending grow much faster than it expects.
The BoE’s Financial Stability Report said: “The FPC does not believe that household indebtedness poses an immediate threat to stability. But it has agreed that it is prudent to insure against the risk of a market loosening in underwriting standards and a further significant rise in the number of highly indebted households.”
It expected the maximum impact of the policy under a boom scenario would be to lower the level of national income by 0.25 per cent.
Against this potential cost, the bank said its actions would “reduce macroeconomic volatility and the likelihood and severity of financial instability”.
Two new restrictions were introduced by the BoE. The first, recommended by the International Monetary Fund, puts a limit on the proportion of mortgages a bank can lend with large loans relative to mortgagors’ incomes.
The limit was set to restrict lending at income multiples above 4.5 to no more than 15 per cent of a bank’s new lending for residential home purchases.
At present, no bank exceeds this limit and the average level of lending above a 4.5 loan-to-income ratio is only around 11 per cent, so it is not binding on any lending, even in the London housing market.
Loans for remortgages that do not increase the principal are excluded from the limit, helping people who already own and might have been excluded from good mortgage deals, as are loans for buy-to-let properties.
In addition to the loan-to-income limits, which the BoE described as “insurance” against future problems, the bank also said banks must ensure new borrowers would still be able to afford their loans if interest rates rose by 3 percentage points in the first five years of the mortgage loan.
The BoE admitted that this limit is very similar to the existing practices of banks, in which lenders tend to assess whether their customers could afford a mortgage rate of 7 per cent, about 2.5 to 3 percentage points above average standard variable mortgage rates that currently exist in the market.