A study from credit rating agency S&P comes as an exercise in the blindingly obvious. It turns out that people with little equity in their homes are much more likely to default on their debt than those with 25% plus – twice as likely in fact.
I’m not sure most of us needed a study to tell us this. It would seem clear to me that those with little equity in their houses would make less effort to keep it: if you don’t really own something, where is the incentive to keep pretending you do, when you could just give up the game and move somewhere cheaper?
It also seems clear that if you do have a good amount of equity the last thing you want is to be repossessed, even if you are having trouble with your payments. Everyone knows that repossessions sell for less than houses sold by their owners. So if you have equity and you are in trouble, you are much better off to sell yourself and get out before your arrears get the better of you. Why leave anything on the table for banks and vulture buyers?
This holds in the US too. Data from investment bank Credit Suisse a few years ago showed that those with less than 20% equity in their homes were three times more likely to miss a payment than those with more than 20%. Clearly, the more your home is worth to you in financial terms, the more likely you are to keep paying the bills on it.
But, beyond the obvious, there might be another message in this. People who come to lenders with a deposit have something people without one just don’t have. They either have a family that can and will back them financially, or they have an income high enough to allow saving. And crucially, they have a saving ethic that pushes them to do it. So they are more likely, the equity aside, to have a financial cushion that will help them through payment shocks (rising interest rates and the like) or income shocks (losing their jobs).
There has been much fuss recently about the impact on the housing market of the Mortgage Market Review (MMR). But the data on defaults makes it very clear that, if lenders want the loans they write to be paid off one day, it isn’t just the income of a potential borrower that they should be taking into account. And it isn’t necessarily just the level of the deposit on offer either; it is the financial personality of the applicant – their propensity to save, for example.
It’s something for housing minister Grant Shapps to bear in mind as the outcry over the new rules – which will insist lenders make borrowers undergo stringent income and affordability checks – gathers steam.
The end of liar loans, 100%-plus loans and interest-only loans might keep house prices down and might mean that would-be first-time buyers have to rent for a decade longer than they would like too.
Recent research from Policis (for the Council of Mortgage Lenders, please note) claims that, under the new rules, 2.2m people who currently have mortgages will not, unless their circumstances change, ever again qualify for a loan.
But the new rules might also reduce defaults and, with a bit of luck, reduce the extremity of the property boom-and-bust cycle we so regularly subject ourselves too.