Financial Conduct Authority  

Warning rules pushing lenders away from low earners

Warning rules pushing lenders away from low earners

The rules surrounding loan to income (LTI) ratios for mortgage lenders have pushed them away from first-time buyers and towards borrowers with larger loans, the Financial Conduct Authority has been told.

A research paper by Adiya Belgibayeva, published as an occasional paper by the FCA today (February 17), explored whether the implementation of the ‘LTI flow limit’ in 2014 had changed the composition of borrowers being accepted for high LTI ratio mortgages.

The ‘LTI flow limit’ is the rule — recommended to the FCA by the BoE’s Financial Policy Committee — which states no more than 15 per cent of a lender’s new residential mortgages can have LTI ratios at or greater than 4.5x.

In effect since October 1, 2014 the rule affects both PRA and FCA regulated firms. The PRA does not stipulate any explicit regulatory cost for exceeding the threshold but FCA guidance states it could require a lender to stop entering into high LTI mortgage contracts if a firm breaks the limit.

In her research paper, entitled Changes in the Mortgage Market post 4.5 limit on LTI ratios, Ms Belgibayeva suggested the rule could result in lenders choosing to prioritise borrowers with bigger incomes and larger loans.

This would optimise a lender’s interest income and maintain the value of new mortgage lending, she argued.

For example, if borrower A has an income of £10,000 and borrower B has an income of £20,000, borrower A can receive £45,000 from a lender while borrower B can take £90,000. 

This would result in the lender increasing or maintaining its lending capacity while it would receive interest on double the loan size.

The paper found the average loan size for high LTI mortgages had increased by between 4 and 7 per cent post implementation of the LTI flow limit.

Ms Belgibayeva said: “For a given LTI ratio, an increase in the average loan size suggests lenders migrated towards borrowers with higher incomes.

“Our results show the change occurred at the 4.5 cut-off, so could be attributed to the FPC recommendation.”

The report also found there were changes to the type of borrower being granted a high LTI mortgage.

There was an increase in the proportion of home movers and joint income applicants — who are likely to have higher incomes — and a decrease in the percentage of first-time buyers being offered high LTI loans.

Today’s paper stated: “These changes in the borrowers composition are consistent with the increase in average loan size for high LTI mortgages.

“We also find evidence that high LTI mortgages have been shifted towards the regions with higher average income and house price, which is also consistent with the increase in average loan size.”

The Bank of England did not comment on the report’s findings, but its own Financial Stability Report (published December 2019) stated the central bank’s general housing measures had a “limited effect to date on mortgage availability”.

It also stated mortgage approvals had increased to “slightly above the levels seen before the FPC’s recommendations were introduced” and the share of first-time buyers had continued to increase since 2005 and beyond the rules being implemented.