Bottoms up! Dispelling first-time buyer myths
Underwriting criteria is actually pretty thorough when it comes to lending, says Karl Deeter
ONE thing that makes me die a little each time is when a person says "we don't want banks making irresponsible loans". The truth is so far from that. To set that record straight, we'll break down exactly how it works to dispel some of the common myths surrounding it.
Firstly, banks underwrite from the bottom up and the top down. Let me explain.
From the bottom up means you look at a person's income and you put aside a certain amount for them to live on.
For a couple, that means you take the bottom €2,000 as being "off limits" for calculating repayment capacity.
Added to that from the bottom down is €250 per child, and childcare expenses as well as any debt servicing or known regular costs you have.
The bottom-up approach means you will have enough to live on and meet your regular costs.
It prevents you from reducing your standard of living to make payments.
The top-down approach is the opposite.
Banks strip away any tax you might pay and then calculate your net disposable income and put a ceiling on that of 35pc to 40pc above which you can't borrow.
What this does is (hopefully) leave some cash in the middle, that is the bit you'll use as a mortgage payment and then a stress test is applied to this amount.
How it works
A quick example will explain this. Take a couple with two kids. The couple has a joint income of €4,200 per month after tax.
The net disposable income the couple can use for a loan is €1,680.
They have to have €2,000 to live on and €250 per child.
So you take €2,500 from the €4,200. This leaves €1,700, less childcare costs. We will say there is €800 in crèche fees too.
That gives €900 to use for a mortgage.
That €900 is less than the maximum of €1,680 that is allowed so there is no issue there.
But next we stress test the repayments over the available term. We'll say it's a 30-year term at 4.3pc.
So you increase the rate by 2pc to 6.3pc and see how much that €900 could afford.
The answer is that it will support a mortgage of about €145,000, which implies a purchase price of just over €181,000.
That will buy you a large choice of homes in rural Ireland, but not much in any of our cities.
It's even harder for a single person, in particular, those who are not highly paid.
This is because they need (depending on the lender) from €1,300 to €1,650 per month, which is their "bottom-up" amount that has to be left over.
The worst off of all are single-income families with children, where you see this it is nigh impossible to borrow a meaningful amount unless the earner is getting close to six figures.
Oddly, this means the choice of one parent staying at home is economically unviable unless you are happy to rent forever.
On top of these layers of precaution are the new rules which are not a replacement, but an addition to the existing ones.
The new rules are no more than 3.5 times joint income (far more conservative than the British opted for) and 80pc loan-to-value (LTV) mortgages other than first-time buyers who can get 90pc up to €220,000 (far more conservative than in Finland who have similar rules).
These rules were pushed in within a few months of their announcement, unlike Finland which had a gradual introduction.
The banks can go over the loan to income rules on 15pc of new lending on a "volume" basis (it's not measured on a 'per number of loans').
And 20pc of new lending can be over the 80pc LTV (loan-to-value) rule.
The "exceptions policy" was created and circulated recently, and in general it favours the well-off because banks will go over on either loan to income (LTI) or loan to value (LTV) but not both.
This hurts first-time buyers the most as they are usually highly leveraged, and even though the evidence shows their loans are safer they bear the brunt of this.
The most obvious way it favours the rich is that to get an exception you have to qualify for far more than you need, to the tune of 120pc.
Take a couple with two children.
The bottom-up approach means you take €2,500 away for them to live on, €2,000 for them and €250 for each child.
But if you want to get an exception you take 120pc of that €2,500 which is €3,000 and take that away for them to live on.
Everybody warned the Central Bank this kind of thing would happen. So the next time you hear anybody talk about "irresponsible lending" re-read this article.
You'll see that underwriting criteria is actually thorough. The soundbite isn't reflected in the facts on the ground of how lending actually works.
Karl Deeter is the Compliance Manager at Irish Mortgage Brokers in Dublin 2 www.mortgagebrokers.ie