Tough mortgage rules ‘must remain’

Should Banks keep their tough mortgage lending criteria in place to help prevent another house price bubble building up in the future?

Some finance experts argue that Mortgages should be capped at 90% of a property’s value, while people should also be prevented from borrowing more than 3.5 times their income. By doing this, borrowers will have both “skin in the property” and not be over extended from the beginning.

The US has experienced several housing bubbles but none as damaging as the most recent. While there were many factors that led up to the bubble, some of these could have possibly been mitigated with the above policy.
They blame the most recent house price boom, which saw property values rise between 1996 and 2006, on loose mortgage lending, which allowed poorly qualified buyer to purchase homes they never should have been able. Exotic lending products, including low documentation loans, Subprime, Zero Down Payment and a combination of these products led to increase risk that eventually reared its head.

While the UK has the highest level of mortgage lending as a percentage of GDP at 81%, compared with 73% in the US and 44pc across Western Europe, the US was a leader in manufacturing exotic mortgage products.

One of the issues was the US’s “addiction” to house price inflation. Everyone just thought that prices would continue to rise. It became a house of cards due to the easy financing. Borrowers who clearly could not afford the mortgage we approved for loans they could never repay. Borrowers were sold mortgage products with the “pitch” that they could refinance down the road. This assumed that there would be mortgage products allowing the refinance and that properties would continue to appreciate to create equity. Both assumptions failed.

Wall Street’s creation of exotic mortgage products made financing anybody with “a heartbeat” possible. The assumption that by pooling mortgage and spreading out the risk of the loans, defaults could be managed effectively. Again this assumption assumed that prices would continue to rise. But as prices rose, home became less affordable. Thus new products requiring less proof of income came on the market. Lack of down payment was an issue so products allowing even more than 100% of the value of the property came on the market. Then products not requiring income proof or equity came out. All of this again assumed that properties would appreciate enough to continue to mitigate and losses in the mortgage pools and the risk could be spread out.

Speculation began to run rampant as weak borrowers bought properties in the hope of “flipping” for a profit to a buyer that would pay more.

In hindsight it was only a matter of time as many of the last loans made in the bubble were to the weakest borrowers.
By requiring larger down payments or more equity borrowers simply reduces the risk as it takes many of the weaker borrowers out of the pool. Those that can save may just end up being better off as renters. While this may go against the “dream of homeownerhip” that is widely promoted by the industry and government, it just might be the reality needed to prevent future meltdowns.

While this may hamper current sales, ultimately it might make a stronger housing market with less volatility.