Even when deposits can be acquired, loan sizes, necessarily limited due to the interest-rate risk, except for those on the highest incomes, are too small to buy anything. The result is that mortgage lending is limited to high-wealth, high-income individuals: in the decade from 2005 there 2.2m fewer first-time mortgages made than in the previous two decades.
In today’s mortgage market, then, regulators and bankers are only able to improve financial stability at the expense of home ownership.
The settlement may be financially stable but it is politically unstable: younger generations will not be content to be the eternal tenants of a new gentry.
Fixed rate mortgages
The CPS proposes an alternative, one that should both satisfy the financial stability demands of the last crisis and allow for an expansion of homeownership: first-time buyers should be offered 25-year fixed-rate mortgages, so that there is no need to stress-test them at higher rates, since they will never pay them. These mortgages should be made at 95 per cent LTV.
In 2018 the average first-time buyer bought a house for £182,700, so we use that price in the following example. At 95 per cent LTV the mortgage would be £173,600, and the stressed payment hurdle would be £1,219, which only 0.65m renting households could jump.
The CPS estimates that a 25-year fix with an early repayment charge in the first five years could be made at an interest rate of 3.7 per cent, and so monthly repayments of £888, which could be afforded by 1.7m households, that is, 1.05m more. The CPS also models a ‘step-up’ mortgage, in which repayments are increased by 2 per cent per year to keep them roughly constant in real terms: in this case the initial monthly payment is £672, which could be afforded by 2. m households, that is, 1.85m more.
These long-term mortgages should be made by institutional investors with access to long-term funding, and which do not bear the risk that their funding costs will one day exceed their lending rate as a bank would.
Banks rely on short-term funding: more than 80 per cent of both Barclays’ and RBS’ funding is repayable within three months. Pension funds and insurance firms would be more natural providers of these mortgages: Barclays’ pension fund is 80 per cent payable over more than ten years and Aviva’s is a third payable over more than 15 years. Denmark’s mortgage market currently operates similarly to the one proposed here.
A mortgage market dominated by owner-occupiers on fixed-rate mortgages made by maturity-matched lenders invulnerable to a run ought to be significantly more stable than one dominated by buy-to-let landlords on variable-rate mortgages made by maturity-mismatched lenders vulnerable to a run.
