What the new lending crackdown means for UK house prices

The property sections are outraged.

Banks have decided that they’re going to be more careful about writing interest-only loans (where you only pay the interest on your loan, then pay the capital in one go at the end of the period).

In the good old days before the bust, you could get an interest-only loan with only the vaguest notion of how you’d repay the capital. You’d mutter something along the lines of, “house prices never fall – the government won’t let them”, and the computer would cheerfully say ‘yes’.

Now the answer is a resounding ‘no.’ Santander for example, won’t lend interest-only on anything above a 50% loan-to-value. In other words, you need to own half the house already before the bank will even think about interest-only. Others have followed suit with similar restrictions.

Of course, unless you’re a mortgage broker, the only shocking thing about these rules is that they weren’t in place before the financial crash.

But the big question is: why the crackdown now?

The horses bolted ages ago – why shut the stable doors now?

New, tighter rules on interest-only mortgages are being blamed on the Mortgage Market Review (MMR). In short, this is the usual story of regulators tackling yesterday’s problem.

The rules on interest-only lending were clearly too lax before the crisis. Rather than change them when they needed to, and take the flak from the property lobbyists, regulators have left it until now, when all the damage has been done.

The review basically puts the onus on lenders to make sure their customers can repay their loans (you’d think that would be a basic function of sensible lending). Trade bodies argue that banks are now reining in interest-only lending for fear of being sued if people suffer a shortfall. 

But I don’t think that’s the whole story. Banks are past masters at evading regulations they don’t like. I think the MMR is an excuse for the banks to tighten up. Here’s why.

Banks haven’t been snatching back brollies

Throughout the aftermath of this financial crisis, everyone has been amazed at the leniency of the banks.

Usually a banker is defined as someone who tries to force an umbrella on you when it’s sunny, then wants it back when it starts to rain. In the current crisis, that’s not been the case.

Banks have been slower to repossess houses, and to shut down struggling businesses. That’s helped the economy to wobble along, albeit with a depressing, lurching, zombie-like gait.

Have they learned some lessons from previous crises?

Not at all. It’s just that in previous crises, banks haven’t been as fragile as they were this time around.

In the lead up to 2008, Western banks overstretched themselves to the point where it would only have taken some very small losses to tip them into technical bankruptcy. In the event, we got huge losses that threatened to wipe out almost every major bank standing.

The central banks stepped in to keep the banks afloat and functioning. They dealt with the ‘liquidity’ problem. And in the case of the very worst banks, they tackled the solvency problem by nationalising them.

But banks in general were still left with a lot of those dodgy loans on their books. They couldn’t dump them all at once – their balance sheets couldn’t take the stress.

Instead, as regular contributor James Ferguson has noted many times in MoneyWeek magazine before, what tends to happen with a banking crisis is that banks ‘deleverage’ in fits and starts.

When the crisis first happens, banks are bankrupt. So they pretend not to be, by avoiding writing down any of their bad loans. Instead, they start calling in any good loans they can, in order to ‘de-risk’ their portfolios.

What happens to the bad loans? It’s called ‘extend and pretend’. Companies are given a longer time to repay loans – the debt is ‘rolled over’. People struggling with their home loans negotiate lower payments – or are moved from repayment loans to interest-only ones. That’s called ‘lender forbearance’.

As time wears on, the banks start to stabilise their balance sheets, aided and abetted by central banks making life easy for them. Meanwhile, regulators are pressing them to start behaving more responsibly (always after the event, of course).

So eventually, the banks get to the point where they feel they need to start addressing some of those dud loans. That’s when they decide they want their umbrellas back.

The end of forbearance

Last week, Paul Diggle at Capital Economics tried to put a figure on how important a role forbearance has played in propping up the UK housing market. “The most common forms of forbearance are a switch to interest-only or a reduction in the interest rate charged.”

Lenders have also taken arrears and added them to the outstanding balance of the mortgage. Interestingly, when this happens, “a borrower is no longer counted as being behind, removing them from the arrears statistics.”

The Bank of England estimates that 11.8% of borrowers have benefited from some form of forbearance. Of these, roughly a third thought they’d be in arrears if they hadn’t been given a break by their banks (and the other two-thirds were clearly chronic over-optimists).

In short, says Diggle, if banks had been less forgiving, then the proportion of mortgages currently in arrears of three months or more would probably be around 5-6%. That’s “in line with the peak reached in the 1990s.”

In other words, if the banks decide it’s “no more Mr Nice Guy”, then the UK property market could run into some serious turbulence in the months ahead. And this crackdown on interest-only might be the signal that forbearance is at an end.

After all, who are likely to be your riskiest mortgage customers? The ones on interest-only deals. If you can offload these people on to another lender while the going is good – or even repossess their home while the market is still defying gravity – then maybe that’s starting to look attractive to the banks.

Of course, if the banks kick off another downward turn in the housing market, pushing prices lower, it’ll hurt them too. But that’s how a banking crisis plays out – in fits and starts. The next dip in the rollercoaster could be right ahead of us.

• This article is taken from the free investment email Money Morning. Sign up to Money Morning here .

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39 Responses

  1. 22/02/2012, Kingbingo wrote

    Sounds good and we can certainly live in hope. Although I have learnt not to underestimate how willing the government and banks are kick the can down the road and defer any pain so long as it keeps bonuses flowing.

  2. 22/02/2012, P Hamilton wrote

    I have personally witnessed this lender forbearance and it quite unbelievable.
    This person was a Starbucks worker on a little over minimum wage. In 2007, with only a £5000 deposit she was lent £150,000 to buy terrace house on Tyneside. The mortgage was of course self-cert, interest-only with a discounted initial rate.
    After the economic downturn began, her already modest income was reduced and she could no longer afford the payments but rather than repossess her lender significantly reduced the interest rate and said she can stay interest-only for the 25 year life of the mortgage.

    The house which she bought from a flipper, was refurbished to conceal serious damp problems. She cannot afford to rectify the damp, but as the mortgage interest is still less than rent for the meanwhile she has decided not to hand the keys to the bank. A realistic sale price for the property is around half what was paid in 2007.
    What kind of irresponsible government allows such thinks to happen?

  3. 22/02/2012, George guest wrote

    Property values even with the aid of massive government support are collapsing all over the country but the positive spin and denial by owners etc is clouding the reality. Zero interest rates make people speculate but more often they are not considering what is backing up the speculation. Auctions are usually the worst place to buy a property as they are too dear and the properties often carry reserves which are too high. Everything I see around me tells me to wait for the real bargains in a few years time when interest Rates rise .

  4. 22/02/2012, Bob Riach: Riach Independent Financial Advisers wrote

    This is too much to late
    And this could be detrimental to people present mortgage arrangements.

    This could also stop people remortgaging for better deals, therefore it’s a benefit for the lenders to do this si that they don’t lose customers to lenders with better rates

  5. 22/02/2012, Nev wrote

    Frankly, I would rather see a lot of forbearance than the kind of social and financial catastrophe the United States has seen with the ruthless evictions, and abandonment of entire streets of homes to rot. That benefits no-one, and in the UK these people would have to be re-housed.

    Since we own quite a lot of the Banks concerned, this would be money out of one pocket and into the other.

  6. 22/02/2012, DavePage wrote

    Rather than all this ‘forebearance’, why don’t we simply legislate to make housing more affordable? The problem in the UK is a shortage of affordable housing, created, aided and abetted by Govt. and BOE inflationary policy to create the illusion of growth and prosperity.

    It would a simple matter to set ALL mortgages at a sensible multiple of average earnings, say 3x individual salary and 3.5x joint salary for couples (removing BTL mortgage interest relief and interest-only mortgages in the process, the latter a process now thankfully and finally underway). Once the large majority of people could no longer borrow £200k to buy an overpriced house, the prices of the majority of homes would fall in-line with these mortgage limits. Key to this is to make interest rates reflect the cost of the sum borrowed by removing the teaser mortgage rates that rely on non-depreciation of the asset to remortgage and fixing the rate for the 25 year life of the mortgage.

  7. 22/02/2012, DavePage wrote

    Do these two things, and the average person in Britain can once again afford the average house, boom and bust would be banished, the moral hazard of making the whole collectively pay for the mistakes (and profits) of the few would fall away, and the economy would never again be brought to its knees because of speculative activity surrounding one of life’s essentials: an affordable roof over one’s head

  8. 22/02/2012, Tony wrote

    Good article, the banks never do things for the good of the public, its always about their own pockets, and often with a short term view, hence regulation is very important to think about the longer term stability.

    #2 – note that it is not possible to hand the keys back and walk away in the UK. If you borrow money you are expected to repay it unless you declare bankrupcy. If the bank reposess and sell for less than the amount owed, you still owe that money. Personally I think its not fair, and banks do not have enough risk in the deal, despite easy bankruptcy.

  9. 22/02/2012, PD wrote

    @Dave Page
    You are assuming that the powers that be actually want people to own their houses. In their world, people buying their houses and putting in roots in an area is an undesirable outcome. The reason being that it stops them moving to areas where there are jobs. They would prefer if people rent and move often to jobs, this is more efficient according to them. Of course this only is for the plebs and not themselves. They were only inflating the house prices for sound economic reasons. The side effect of enriching themselves as their property values inflated was just something that they would learn to live with.

  10. 22/02/2012, Andy Hardie wrote

    DavePage for PM

  11. 22/02/2012, Shinsei67 wrote

    @DavePage

    “Once the large majority of people could no longer borrow £200k to buy an overpriced house, the prices of the majority of homes would fall in-line with these mortgage limits.”

    Alternatively the rich/foreigners/investment institutions would just buy up all the properties in the UK and we would be back to the situation existing in the C19th where 90% of properties were owned by the richest 10%.

    You’d just be making life very attractive for the rentier class.

  12. 22/02/2012, P Hamilton wrote

    #8. Tony

    Yes, she is aware bankruptcy would be required to walk away from the debt. But if unless you’re a business person, an accountant or such like there is little detriment to going bankrupt these days.

    My point is lenders will do almost anything these days to avoid an outright default.

  13. 22/02/2012, P Hamilton wrote

    #11. Shinsei67

    One would hope that any Government with a policy of promoting home ownership would legislate and change the tax system to avoid that.

    However, for the last few years they seem happy to let anyone buy property as long as it supports prices.

  14. 22/02/2012, Ravi wrote

    The obsession with property prices is largely driven by one thing: Owning properties is perceived (wrongly) as an easy way to print money.

    As a result, many home-owners have become home-owned!

    The only purpose of a house is to provide shelter. It is not a cash-point machine!

    The main driver of property prices is the availability of credit. If easy and cheap credit is available, the price will rise fast. The financial disaster (in the US, UK, Ireland and other countries) in the last few years was primarily caused by irresponsible lending to the property sector. The government, regulators, banks and the borrowers must take responsibility for what happened.

    What needs to be done is to move away from wasting precious resources on property and speculation and invest in industries – especially knowledge industries that create long-lasting benefits.

    If banks can check now the borrowers’ ability to pay, what didn’t they check 10 or 15 years ago?

  15. 22/02/2012, DavePage wrote

    Shinsei @11

    Simple: put limits on the number of properties any individual, married couple or company may own: a maximum of 2 per person / couple (with 90% CGT on the second) and, say, a maximum of 5 per company. Companies could continue to own as many flats as they like, so that we don’t extinguish housing associations, but freehold properties should only be available to those who do not already own property up to these maxima.

    Your suggestion that these ideas would be “…making life very attractive for the rentier class” is curious because it is the lack of such legislation that has allowed such people to build the large property portfolios that keep us all in their grasp, producing the very lobby that our politicians and banks both pander to. Moreover, your statement implies that high house prices should be maintained in an effort to stop the rich buying too many, hardly realistic and something that ignores the very problem of affordability for all.

  16. 22/02/2012, PV70 wrote

    DavePage, unfortunately the only real solution is to let the market run its course. Policy of all time low interest rates is not helping but inability to remortgage high leveraged interest only loans certainly will.

    Interest only mortgages have been the very basis of the problem, with a myth of ‘house prices can only go up because there’s a shortage of property…’.

    Much has been talked about ever-increasing rents recently. At the end of the day, a property is worth what someone is willing to and able to pay, be it sold or let. My rent in North London hasn’t gone up for three years. I simply couldn’t afford to pay any more but luckily the landlord doesn’t want to risk keeping the property empty.

  17. 22/02/2012, max wrote

    dream on. The government has set interest rates so low to stop a housing crash. They will do anything to stop it. it will not happen. If necessary they will reduce the value of sterling to zero in an attempt to prop up the housing ponzi scheme.

  18. 22/02/2012, DavePage wrote

    For anyone who would like to see how a politician responds to these issues (i.e., one of Shinsei’s ‘rentier’ class) see the debate I had with John Redwood MP on his blog four years ago (http://johnredwoodsdiary.com/2008/05/17/why-has-the-government-and-the-bank-of-england-failed-us-on-inflation/)

    I feel very passionately this issue, both as someone priced-out of home ownership in his home country and one whose savings interest is being confiscated every month to fund this ‘forebearance’ for those who bought houses they could not afford with money they did not have (interest on savings accrued by hard work I should say, rather than the untaxed windfall of house price inflation).

    Max @ 17: Unfortunately, I suspect that you are right, which is why I have given up any prospect of ever owning my own home in the UK and am trying to emigrate — another aspect of house price inflation that, in numbers, will have its own economic consequences down the line…

  19. 22/02/2012, Chris wrote

    The housing bubble was a deliberate creation of the BoE in league with the Government and regulators. There was no incompetence. To compensate for Globalisation having hollowed out the UK economy Brown and BoE had to create a false economic boom to cover up the damage. Having house price inflation included in the inflation figures would have meant that the bubble would never have formed so that is why it was left out. Creating manipulated booms and busts also reinforces a societal structure based on a pyramid shape with the 1% at the top having excessive wealth. Government do not want low house prices for the little people because it would eliminate a pliable workforce who are mortgage debt slaves. Debt is control.

  20. 22/02/2012, Chris (but not 19. Chris) wrote

    Different Chris here, I’m sure Gordon Brown made some mistakes but I happen to believe he was a very well meaning politician with good values.

    To the author, I couldn’t help thinking this statement was a little hypocritical-
    ‘Rather than change them when they needed to, and take the flak from the property lobbyists, regulators have left it until now, when all the damage has been done.’
    - as from the cut of your jib I imagine you were one of those vehemently and generically opposing all forms of regulation in the pre-2008 years.

    Interesting article though, on the issue of house prices I have found the MoneyWeek e-mails very informative and the position of expecting a decline in U.K house prices (at least outside London) makes sense to me for all the reasons discussed. I wander though what the situation is in terms of number of people looking for new homes and availability and how many are planned to be built?

  21. 22/02/2012, Boris MacDonut wrote

    #2 P Hamilton. I can better that. At work I saw a loan by an HBoS subsidiary named after England’s second city, in 2006. The loan was made to a recently released convict who earned at best £12,000pa as a taxi driver. He lied on his self -cert to say he made £35,000 and his dodgy accountant backed it up. They lent him £420,000 (12 times supposed income). He also got carloans of £90,000 and ran up credit card bills of another £100k in 9 months. None of this was ever repaid and not one instalment on the mortgage. On the £450,000 house he “bought” the local council gave him £65k in housing benefit. I told the FSA.They said go away.

  22. 22/02/2012, P Hamilton wrote

    #21. Boris MacDonut

    Your ex-con sounds like a perfect role model in Gordon Brown’s borrow and splurge society.

    It’s people like me who saved and didn’t get into debt who are the fools.

  23. 22/02/2012, Chris wrote

    #22 P Hamilton

    Indeed it’s people like you and me who didn’t buy into a Ponzi fascist economic scheme that have lost out.
    Since the BoE likes to deliberately create bubbles in the housing market it will only be a matter of time before they do it all again. Knowing/believing that should it collapse they will be bailed out again at the expense of the savers everyone will effectively pile into housing (including the savers) as soon as the first whiff of a bubble is detected. This should therefore create the mother of all bubbles. What will prevent this scenario taking place?

  24. 22/02/2012, Simon wrote

    If the housing boom was down to Gordon Brown why did it happen all over the West?

    If the NICE (no inflation, constant expansion) decade taught us anything it is that the major factor influencing house prices is how much a bank is willing to lend, not how much a person earns.

    Banks will stop the extend and pretend once they’ve fully recharged their reserves with the extra cash they get from not passing on the ultra low BoE interest rates.

  25. 22/02/2012, Chris wrote

    #24 Simon

    The housing boom was in many Western countries because the central banks act in concert. They have regular meetings (eg at places like Jackson Hole) where they no doubt agree a strategy. That strategy from 97 to 2007 was to create a false economic boom based on too low interest rates in order to compensate for the hollowing out of the Western economies by Globalisation moving manufacturing to the East. In the UK Brown and the BoE were responsible for doing their bit. Now that the boom has ended people can see how much damage has really taken place. Checkout Detroit to see what has happened to that city.

  26. 22/02/2012, Nick wrote

    So we all seem to have the same opinion.

    And I can see the same opinions in PricedOut, SaveourSavers and House price crash.

    Why is the goverment ignoring us (dont care about MPC)?

  27. 23/02/2012, carol42 wrote

    When we bought our first house in 1976 we had an interest only mortgage but we also had to take out an endowment policy to cover the loan when did that stop? it helped us get started and on our second we kept the endowment and took the rest in repayment. By the third almost all was repayment and finally we were able to buy our final house outright. We always stayed a long time and it was always our home never used as a cashpoint and we survived several recessions and redundancy in the 1990s.

  28. 24/02/2012, Roberto Birquet wrote

    Nev
    Frankly, I would rather see a lot of forbearance than the kind of social and financial catastrophe the United States has seen with the ruthless evictions, and abandonment of entire streets of homes to rot. That benefits no-one, and in the UK these people would have to be re-housed.
    ———————-
    What about the US first-time buyers who can now afford a home for their family? What ab out future FTBs who not have to find $100k deposits, or an economy without a hugely indebted private sector?
    What about people able to pay lower prices and have money remaining for pension provision so the state is not burdened? Lazy thinking sir, and we have along and painful price to pay for this save the banker and debtor.

  29. 24/02/2012, dickyjim wrote

    @carol42:

    Endowments certainly aren’t the way forward. For the main part they are simply the means by which a financial adviser enriches himself at his client’s expense. It just so happens that your mortgage paying life coincided with astronomical gains in the stock markets during the 1980s and 1990s which happily for you meant that the endowment vehicle worked as sold. It wouldn’t have worked in the preceding 20 years and it most certainly wouldn’t have worked post 2000.

    The only sensible way to repay debt is through the simple vanilla repayment process. If there is spare money to invest in other schemes that may or may not work then that is fine but the vanilla repayment process should remain in place regardless. This is the way to prevent excessive lending and borrowing and thereby keep property affordable.

  30. 24/02/2012, Adam wrote

    A shift to a Land Value Tax would sort the problem out. http://www.guardian.co.uk/business/economics-blog/2012/feb/02/ifs-backs-land-value-tax

  31. 24/02/2012, Manny wrote

    What has happened to the raging property bulls that always commented on why house prices will never go down.

    They were absent on that other MW property article where the towel was thrown in by famous MW property bear, forget his name.

    I stick with my forecast 2007 peak prices -70% before this bear market is finished.

    -90% would be too much downside even for me.

  32. 24/02/2012, Boris MacDonut wrote

    #31 Manny calling it a “forecast” does not excuse you from the charge of trying to predict the future. To suggest UK house prices will fall to an average 0f £60k when income is already at £34k is laughable. Best guess at the moment is a 30% rise by 2020,but anything can happen.

  33. 24/02/2012, liberal conlab wrote

    #26 Nick

    The only way the gov will listen to us is if we all vote independent the next time round. Actions speak louder than constant pleading.

  34. 25/02/2012, NeutronWarp9 wrote

    House price movements are simply a reflection of the economic system as a whole, and is at least one aspect (of it) that the masses can participate in with some basic understanding: affordable payments + rising value = result.
    In this hideously simplistic equation there are winners and losers, based largely upon the way the economic tide is moving at the time. Human nature kids itself when money is made that it was down to individual genius and when money is lost it is somebody elses fault.
    Most of us know the rules. Life is a risk and investment even riskier – no matter what systems and values we put in place.

  35. 25/02/2012, max wrote

    @Manny – what’s happening outside london to property prices. In London it is CRAZY. I can’t believe that people are ‘asking’ 10% more than last year. YES 10%. There are too many people in this city and it’s too easy for non residents of uk plc to buy property here. And sterling is worth less every day.

  36. 26/02/2012, Paul wrote

    # Boris, the average UK salary is not £34k, and 30% rise by 2020? lol. In which case you are assuming salaries rising at similar rate? In this economic environment?? And when the economy does improve, where will interest rates rise to?? 5/6%?? And if your looking at this 30% rise by 2020 as an investment point of view, factor in 8 years of inflation at 4% (generous) and you get a real return of -2%. Every cloud and all that……..

  37. 27/02/2012, Manny wrote

    #32 Boris

    forecast may be wrong word, my speculation on property prices

    my speculation is based on very simple maths

    who here knows of anyone on an average wage say £25,000 pa (or, lets double it, £50,000) that has manged to save £160,000 over 25 years????? This is what you are trying to do at 0%. Now find me someone on an average wage that has manged to save/payback £160,000 paying interest accruing at 3% on that sum, what about interest rates at 6%

    it is as simple as that, prices will come down to the amount an average person can save over 25 years

    history will show that is not a very large amount. it is definitely not £160,000 even at 0%

    stick around and you will know I am right and my maths make sense
    time is on my side

  38. 27/02/2012, Manny wrote

    #35 Max

    At one point prices could never go down anywhere.

    Now prices will never go down in London. Space for the bulls is definitely contracting.

    As in my previous post, people can “believe” whatever they want but maths and numbers never lie and the maths will overcome London as well.

    Psyche has changed for rest of the uk and it will dawn on Londoners soon. Acceptance that prices can go down is the most important part in starting the property bear market. We are getting there, this was the point in my post at #31 ardent property bulls are getting thinner
    Unless I am just imagining it all!!

    If I am wrong I will be happy to admit it, but time is on my side.

  39. 28/02/2012, Boris MacDonut wrote

    #36 Paul. I did not say UK salary is £34,000, I said Income. Average income is very different from pay, as pay now only accounts for 60% of UK income. Average pay I see is close to £28,200 but house purchase is not confined to those who have salaries and even they are not constrained to paying only from their salary.
    #37&38 Manny. This is a bit weird as most house are bought by couples,i.e two incomes. £160,000 over 25 years is just £530 a month or 28% of take home pay.

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