Relaxing income limit is bad solution to a bigger problem
Loan-to-value restriction is designed to protect the banks and the taxpayers, writes Colm McCarthy
Published 03/04/2016 | 02:30
There is no national housing crisis. In most parts of the country second-hand homes are for sale at prices that are affordable and below the cost of construction. The deposit required under Central Bank rules in these areas is no more than the price of a small car. Rents are also modest in most counties and there is little need for new construction.
There are two serious housing problems. Those without the means to house themselves are unable to access social housing, hence the long council waiting lists around the country. In Dublin and a few other urban areas, house prices are returning to bubble figures. There is limited new supply even though second-hand homes trade well above construction cost. People on middle incomes in Dublin feel priced out of home ownership.
It is vital to be clear that neither of these pressing problems is addressed by a relaxation of the Central Bank's mortgage lending rules. The Irish banks went bust (every single one) for lots of reasons, but excessive provision of finance into a dysfunctional housing market was at the heart of the disaster.
The Central Bank's chief economist Gabriel Fagan, stated on Friday that the rules are here to stay. But every politician in the country seems to want a relaxation, as do the builders and some bankers, surprisingly. Two of the banks are already plugging a '2pc cash-back' offer, borrowed from the car showrooms and an obvious attempt to circumnavigate the loan-to-value cap.
The Central Bank rules were introduced for good reasons. It is not even possible, never mind prudent, to remedy failures in housing policy through excessive and risky provision of mortgage credit. There are two prudential rules, introduced 12 months ago, for residential lending. The loan-to-value rule translates into a minimum deposit on a sliding scale from 10pc upwards for first-time buyers. The chart below shows how it works.
If the loan is from either of the '2pc cash-back' lenders, the bank is also lending a portion of the deposit and these figures can be reduced by 2pc for both categories of borrower.
The loan-to-value limit is designed to protect the banks and their involuntary sleeping partners, the taxpayers. House prices can go down as well as up, borrowers can lose their jobs, the loan may default and the collateral may have to be realised. That these modest minimum deposit requirements have to be enforced by the regulator is evidence that some bankers yearn for the good old days of the 100pc mortgage. This should make you feel scared.
There is also a requirement that the loan be no more than 3.5 times the borrower's gross income. This limit protects the lender but also the borrower. These are not onerous limits and both rules provide some wriggle room for the banks. Prudent banks, particularly ones brought back from the dead courtesy of the taxpayer, should not need to have common sense imposed by the regulator.
The '3.5 times gross income' rule did not come out of thin air. Banking regulators around the world have had plenty of time these last few years to study default rates in residential mortgage lending. The Irish Central Bank has not exactly been starved of data. There is evidence that default rates, in response to a housing crash or to borrower difficulties, begin to rise once the loan amount exceeds a threshold. That threshold seems to be somewhere around the 3.5 level.
An interesting feature of the Central Bank rules is that they apply uniformly across the country, even though the dysfunctionality of the housing market is not uniform at all. Pay scales in Ireland are not differentiated geographically and a person on €35,000 per annum can be lent 3.5 times this amount (up to €122,500) everywhere, even though house prices vary enormously.
In midland counties, say Tipperary, family homes around 1,200 square feet are quoted at €130,000 or thereabouts. The first-time buyer will need €13,000 for the deposit and the loan balance is comfortably inside the income cap. A single person on average income in the premier county can reasonably aspire to home ownership.
In the outer suburbs of Dublin a similar property will cost €300,000. Even if the deposit of €38,000 can be scraped together the buyer needs a gross income of almost €75,000 to qualify for the loan needed, given the income cap. Very few single people in the first-time buyer age-group make this kind of money and couples who do face the loss of the second income, or heavy childcare costs, making them less viable as borrowers. The result is a city where young people with decent jobs are giving up on the possibility of buying a home. The alternative is an exit to the midlands and a long daily commute through the empty prairies which surround the city.
One bad 'solution' would be to relax the income limit, favoured by some bankers who realise that the deposit requirement is not the main constraint. At current inflated variable mortgage rates they are understandably keen to lend. But lending young people large multiples of income to buy properties at artificial Dublin prices exposes both lender and borrower to the risk of a sane housing policy.
Suppose a future government decided to deal with the artificial supply constraint in the Dublin area by removing the scarcity of zoned and serviced land. Prices would fall back towards construction cost and the banks would be up to their gills again with negative-equity borrowers and strategic default. Bankers urging higher income multiples must be confident that a sane housing policy for Dublin is unlikely.
They could be taking comfort from another bad idea touted in several election manifestoes, namely further subsidies on the demand side, like the first-time buyer's grant or the return of mortgage interest relief. These measures would increase demand for a given supply and hence push up prices even further.
The available stock of social housing in Ireland has been eroded substantially through the practice of selling houses to local authority tenants at large discounts. This scheme was suspended some years back but the latest wheeze is to restore it and to force voluntary housing associations to expose their social housing stock to erosion in the same fashion. This, note, is at a time when there is universal agreement that more social housing is needed.
A final bad idea which builds no extra houses would be to differentiate pay scales by region, compensating Dublin employees for the higher cost of living induced by the failures of housing policy. This is already a feature of the equally dysfunctional UK housing market: London-based employees in many public service occupations receive what is called a London weighting, often about £3,000 to £4,000 per annum. This makes little difference to housing affordability but produces plenty of industrial relations hassle.
The current push for pay increases in the Irish public sector reflects, at least in part, excessive accommodation costs in the capital. There are no striking Luas drivers, on average pay of €44,000, in Tipperary.