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Mortgage lending: are homeowners overstretching?

As the good times rolled in the mid-2000s, only a precious few sounded the alarm as lending became increasingly reckless. Northern Rock's infamous 'Together' 125 per cent mortgage epitomised the rush for high loan-to-value (LTV) deals at a time when it was thought that house prices would just keep going up forever.

We all know how that story ended, and politicians and economists alike swore there'd be no return to those bad old days.

Yet barely a decade later, concerns are being raised that homeowners are once again beginning to overstretch themselves. Recent data from the Bank of England revealed that more than one in 20 mortgages taken out between July and September involved an LTV of 90 per cent or more - the highest level since the end of 2008. The Bank's figures also flagged that collective outstanding mortgage debt by the end of Q3 was just under £1.49bn, representing year-on-year growth of almost 4 per cent.

Are we making the same mistakes again?

The primary risk with high-LTV loans is negative equity. Every economic cycle runs its course, and we are now more than 10 years into the current one. The timing of the next recession is anyone's guess, but it will come at some point in the future, and house prices will fall. The danger is that many borrowers will then leave themselves exposed to the mire of negative equity, and be forced onto expensive standard variable rates when the time comes to remortgage; struggle to sell if they need to move, or lose their home altogether.

Separate data from Moneyfacts also shows that borrowers are taking out mortgages for longer, and lenders are bending over backwards to accommodate them. The figures reveal that six in 10 mortgage deals have a standard maximum term of 40 years, relegating the traditional 25-year mortgage to the second tier. Indeed, the share of 30 to 35-year mortgage terms snapped up by first-time buyers has rocketed from 16 per cent to 36 per cent since 2007. In turn, the proportion of terms between 20 and 25 years now accounts for just one in five deals. 

To enable this, lenders have rapidly increased their cap on age limits, and many homeowners will be paying off their mortgage well into their eighties. The risk is that people simply won't be able to afford to fully cover this debt over the course of their working lifetimes.

The other threat associated with high-LTV deals is the exposure to increases in interest rates. After a decade at rock bottom, the feeling is that rates must normalise at some point. If they do, it will add a cost burden for most homeowners, but those who have stretched themselves most to cobble together a deposit will be at greater risk of finding themselves in financial difficulty.

It's not as bad as it may seem

The above-listed concerns notwithstanding, a closer look at the figures suggests the overall picture may not be as grisly as first thought. For starters, the share of mortgages being taken out at the top end of the scale (ie: 95 per cent or more LTV) has remained unchanged over the past 12 months, while the equivalent figure for mid-range home loans (circa 75 per cent LTV) has actually increased.

There has also been a near 6 per cent rise in the number of first-time buyers in 2019. In a climate of stagnating house prices, stamp duty exemptions and a raging mortgage price war, an extra 2,000 first-time buyers are making the step up onto the property ladder each month, which would likely go a long way to explaining the corresponding increase in 90 per cent LTV home loans.

As for borrowers extending their mortgage terms, the reality is that life expectancy is going up, and, in an ageing population, we will retire later. The future for working people is an uncertain one, but, nevertheless, the assumption that we'll be earning an income for longer is a reasonable one. And while it means paying more interest over time, a longer mortgage term also gives borrowers the flexibility to lower their monthly outgoings, and provides room for manoeuvre if interest rates go up.

The new normal

Yet on this point, there is a view that rates may not return to levels previously considered 'normal' anytime soon - if ever. As we wrote recently, it is negative interest rates which could become increasingly common at a time when technological advances are applying downward pressure on prices, and an ageing population is reducing its levels of economic demand.

The consequences for mortgages in such a scenario are difficult to fathom, but in Denmark we have already begun to see loans disbursed whereby the borrower is, in effect, paid money to take on the debt.

Whether such extreme cases will become the norm is open to debate, but it does lend credence to the theory that rates won't be going up significantly in the short-term, which is good news for homeowners with high LTV, long-term mortgages. How beneficial this low-rate climate is for the wider economy is another question altogether, but it does seem unlikely that fears of mass foreclosures induced by surging borrowing costs will come to pass anytime soon.

Risk is unavoidable

The nature of mortgages, and even lending in general, is that risk is inherent. Circumstances are always subject to change, and any range of economic phenomena could damage the market. And of course, we may come to look back on some of the current lending practices with regret.

But this is far from inevitable, and even if a worst-case scenario were to eventuate, it wouldn't be due to the same mistakes being made prior to 2008. On the contrary, the tougher set of rules for mortgage lending, which came into effect in 2014, mandate a level of stress testing on loan applicants which is far removed from the lax lending that precipitated the previous crash.

And there is one more key point. In a housing market with rental costs on a par with, or even exceeding mortgage repayments, the decision by first-time buyers to hop onto the housing ladder instead is perfectly rational. Rational for them, and, if they can afford it, rational for the lender too. As long as this fine balance is maintained, and the lines of affordability don't begin to blur, the hope is that the ghosts of 2008 will be laid to rest, and a society with higher levels of homeownership will endure.

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