Regulator’s strict mortgage curbs face a baptism of fire

The recent rapid rise in house prices has rattled the Central Bank. Still smarting from criticism that it didn’t do enough to rein animal spirits during the Celtic Tiger house price boom, it has published a “consultation paper” on mortgage lending standards.

While lenders have been invited to submit their opinions on the Central Bank’s proposals, in practice it would seem that it has already made up its mind.

In the pre-Celtic Tiger era, banks and building societies would only lend homebuyers 80pc of the total purchase price. Would-be purchasers had to beg, borrow, steal or save the other 20pc.

Not alone did homebuyers have to come up with a hefty deposit, lenders were also only prepared to lend them a low multiple of their income, typically two-and-a-half times the main income and one times the second income.

That all changed during the Celtic Tiger years. The banks threw caution to the winds. The requirement for a 20pc deposit was abandoned as 90pc and even 100pc mortgages became the norm while the banks paid out loans equivalent to five and even more times the borrower’s income.

With entirely predictable results. The major Irish banks had €34bn of mortgages that were in arrears and a further €12bn of restructured mortgages that weren’t in arrears on their books at the end of June, according to the latest Central Bank arrears statistics. That’s the equivalent of a third of the total €136bn of mortgages outstanding. Car-crash banking.

Now that house prices are recovering, the Central Bank is anxious to stop the banks losing the run of themselves once again.

It is proposing that most new mortgages will not exceed 80pc of the purchase price and that homebuyers will have to come up with a 20pc deposit. Banks will also be restricted to lending three-and-a-half times a borrower’s gross income.

The restrictions on buy-to-let mortgages will be even more severe with the banks generally banned from lending more than 70pc of the purchase price.

While there is some wriggle room – 15pc of new mortgage lending will be allowed to exceed the 80pc cap and 20pc to exceed the 3.5 times income multiple – these new regulations will act as a severe dampener on the mortgage market if they are implemented.

Figures published by the Central Bank show that 44pc of new mortgage lending in 2013 exceeded the 80pc value ceiling, while 23pc of new lending exceeded the 3.5 times income multiple.

With mortgage volumes picking up in the past year, admittedly from very low levels, the Central Bank estimates that up to €3bn of new mortgages could exceed the 80pc cap by 2016.

While the two major banks have been publicly silent on the proposed lending criteria, Ulster Bank chief executive Jim Brown has been less circumspect.

“A rebound in property prices following a crisis is not unusual, however, we recognise the need for the Central Bank to take steps to avoid overheating the credit and property markets. The measures though, could have unintended consequences around home ownership which go to the heart of Irish society. The proposals as they stand, will impact the ability of many first-time buyers to acquire their home, in addition to this, other hopeful first-time buyers will struggle to save a higher deposit while paying increasing rents”.

The proposals have also drawn fire from other quarters.

“What the Central Bank is proposing to do is unique in the world. They are introducing a ‘hard’ cap. Unless prices fall rapidly, people will be worse off by waiting,” says Karl Deeter of Irish Mortgage Brokers.

Mr Deeter also points to the possible social implications of the Central Bank’s lending restrictions. “These restrictions will have no effect on cash buyers or on those whose parents or relatives have cash”.

He is also critical of the timing of the Central Bank’s move. “They are doing it now when credit is anaemic. It’s like giving someone chemo for a cancer that they might get in the future.”

Opposition to the Central Bank’s proposals isn’t confined to the financial services sector. There have also been rumbles of discontent from backbench Government TDs. This has led to suggestions that the Government could insure some or all of the amount by which a mortgage exceeded the 80pc cap.

While such a move is superficially attractive and would help homebuyers without the wealthy parents or relatives able to provide the cash for a deposit, it leaves the State on the hook if anything goes wrong. With the taxpayer having already had to shell out €64bn to bail out the banks, is this something that we really want to be doing?

Unless the incipient housing bubble pops quickly, the Central Bank finds itself in an unenviable position. Damned if it does and damned if it doesn’t.

How do they do it abroad?

The Central Bank’s proposed restrictions on mortgage lending are closely modelled on those used in many other countries. While such restrictions haven’t entirely eliminated property price bubbles they do seem to have stopped the banks from getting into serious trouble.

Hong Kong was first out of the traps when it introduced a cap on the proportion of a property’s value that a bank could lend to a buyer way back in 1991. The cap is lowered (ie: buyers must come up with a higher deposit) when house prices are rising, and increased (ie: buyers need a smaller deposit) when prices are falling.

This example has been followed by many other countries with Singapore introducing a mortgage cap in 1996, Canada in 2008, Sweden in 2010 and Norway in 2011. The latest countries to announce plans for mortgage caps are Finland and the UK. In addition Denmark and Italy have brought in “soft” mortgage caps with lenders being “discouraged” from lending more than 80pc of a property’s value.

So do mortgage caps actually work?

The problem when seeking to answer this question is that they haven’t been in place for long enough to provide a definitive answer.

Even the record from Hong Kong, which has had a mortgage cap for more than two decades, is decidedly mixed. Hong Kong property prices fell 40pc after the 1997 Asian financial crisis but delinquent mortgage levels remained low at less than 1.5pc.

A recent paper on Hong Kong’s mortgage lending caps concluded that: “LTV (loan to value) policy is effective in reducing systemic risk associated with boom-and-bust cycles in property markets”.

Well maybe… but, as the continuing volatility in the Hong Kong property market demonstrates, the boom-and-bust cycle hasn’t gone away. In practice what seems to have happened is that more of the risk has been transferred from the lender to buyers, whose deposits will be wiped out first by any fall in property prices.

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