The UK mortgage market may need an overhaul, not handouts

Even as the Bank of England hunkered down for a protracted period of high rates, it was always vanishingly unlikely that the government would step in to help homeowners facing a steep jump in mortgage payments as low-priced, fixed-rate periods end.

Rightly so. The impact of rising interest rates on the economy has already been blunted: nearly 40 per cent of households own outright, according to Schroders, up from a third in 2012. Younger people have been pushed out of home ownership, with just a quarter of households owning with a mortgage.

Widespread mortgage assistance wouldn’t just be counterproductive in terms of monetary policy. It would be wildly expensive, says Resolution Foundation’s Torsten Bell. He puts the cost at £15-20bn, three-quarters of which would go to households in the top 40 per cent of the income distribution. He favours targeted help, using the support for mortgage interest scheme designed for those on means-tested benefit.

The government (and indeed the Labour opposition) have opted to put pressure on the banks to do what they should be (and to some extent are) doing anyway. There are, according to UK Finance, 800,000 households set to roll off teaser rate deals in the second half of this year, with a further 1.6mn due next. Struggling borrowers should be able to offset some of the pain through mortgage term extensions, interest only options or other forbearance.

This crisis should prompt longer-term questions about the peculiarities of the UK market, where home ownership has fallen to about 65 per cent, a level last seen in the mid-1980s.

First-time buyers have been increasingly shut out of the market, in part by the requirement to raise a big enough deposit as house prices sky-rocketed: the average first-time buyer deposit has risen from 0.7 times the median salary after tax in 1990s to 2.3 times, says Andrew Wishart at Capital Economics.

A serious house price crunch could ease that constraint. But these mortgage ructions will make things worse for would-be buyers before they (potentially) get better. The availability of high loan to value mortgages fell and their cost rose sharply in the UK after the financial crisis. The number of 95 per cent LTV mortgages on the market has dropped much more sharply over the past year than lower LTV products, according to Moneyfacts. The financing first-time buyers generally need is getting harder to come by.

Second, buyers will be squeezed by affordability checks given higher interest rates. The Bank of England last year scrapped one requirement to test at standard variable rates plus 3 percentage points. But banks have other regulatory obligations and most are testing at standard variable rates (of approaching 8 per cent) plus 2.7 percentage points, according to UK Finance, based on market rate expectations. 

“This situation does really demonstrate the need for long-term fixed rate mortgages,” says James Browne at the Tony Blair Institute. “A house price correction won’t be enough to reverse falling home ownership without reform of the UK’s mortgage market.”

The prospect of 25-year fixed-rate mortgages conjures up the state-orchestrated US system, another extreme with its own problems. But, with little lending at over five years fixed and essentially none over 10, the UK looks an outlier even in Europe: Spain, the Netherlands, Germany and Denmark all have both more variable rate borrowing and a much bigger share for long-term fixed-rate mortgages. The latter don’t require affordability stress tests in the same way — and, says Browne, small regulatory changes could encourage banks to offer this option in the UK.

The UK also looks unusual when it comes to the cost and availability of high loan to value mortgages. It has tinkered with mortgage guarantees for this part of the market but many other countries have a permanent, and more extensive or compulsory, guarantee system. Such guarantees or insurance (which doesn’t have to be state provided) changes the risk profile of this lending for banks, and at least keeps that part of the market open when lenders are worried about house price falls.

This interest rate shock will prove uncomfortable for many, both financially and politically. But it should also prompt fresh debate on what might create a less dysfunctional mortgage market in the future.

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