Loan-to-earnings rise could rock the housing market

David Alexander on the threat posed by high lending ratios

The news that lenders had once again reached six times loan-toearnings ratios in lending is a concern for future property market stability.

The highest ratio currently on offer is six times income, by the Darlington Building Society, which tellingly, has not offered this scale of loan since 2007.

Other lenders are offering 5.5 times earnings, while the average ranges between 4 and 4.75. So there has been a gradual increase in the amounts being offered since 2008, when such offers disappeared almost overnight from the marketplace.

In the UK, the average house price peaked in September 2007 at £190,032 and fell sharply in subsequent months.

It did not reach that figure again for almost seven years until August 2014.

It took nearly seven years for average house prices to reach their earlier peak in the UK and England, and in Scotland it took nine years.

A generation of homeowners has grown up with extremely benign interest rates and are unaware of just how they can rise in a relatively short period.

They want to borrow as much as they can and, it would appear, lenders are complying.

Optimists will argue that the ratio doesn’t matter if the individual can afford it and, of course, that is true.

However, it makes a lot of assumptions, including no change in a mortgage payer’s personal circumstances, no impact of Brexit on the market and employment, no increase in interest rates, flat inflation and so no rising costs to challenge a homeowner’s ability to maintain a budget, and that house prices will inexorably rise.

With so many variables there is plenty that could go wrong. But there is good news.

Although these very high ratios are available the average scale of lending is much lower.

In the latest month, for which there are figures, first-time buyers borrowed an average of £171,830, which was 4.1 times the average household earnings.

Existing owners who moved home borrowed an average of £223,684, or 3.9 times average household earnings.

Therefore, although some ratios on offer are very high, they are at the extreme edges of the marketplace.

Letting such ratios get higher and given to a larger number of borrowers is where the concern lies.

While a few borrowers may be in a position to service such debts even if interest rates rise, it should not become the norm if we are to avoid a similar fallout seen in the last property collapse.

It is important that lending should remain controlled and reasonable.

Interest rates have been so low for so long that you could be forgiven for thinking that they will never reach 5 or 6 per cent again.

Given that Brexit has placed us in the midst of a major political upheaval, that situation may change rapidly to cope with an economy in flux.

Therefore, lending should be as free and open as possible but still build in appropriate leeway to individuals who may find that their once affordable mortgage has become very unaffordable.

The market can cope with a few people in that situation, but when it starts to be thousands who can’t pay their mortgage then we may be in trouble.