Published: 5 Feb 2015 by Adam van Lohuizen

On Monday, the Chancellor announced that he will grant the Bank of England’s Financial Policy Committee (FPC) powers to limit how much lenders can lend to people buying houses, based on the property value and the borrower’s income.

The changes are definitely a step in the right direction, and Shelter supported them during the consultation process run by the Treasury because they can help control house prices. But we think they need to go further. Buy-to-let (BTL) mortgages are currently excluded (despite the FPC asking for them to be included), and their use is restricted to addressing material financial stability risks. We think they could do so much more for housing affordability.

Macroprudential regulation – an example

Let’s say that the FPC sets a debt-to-income (DTI) ratio limit of 4, and a loan-to-value (LTV) ratio limit of 80%. The table below shows the amount a home buyer could borrow at incomes of £25,000 or £30,000. The purchasing power of the borrower is the sum of the deposit, and the lower of the two borrowing limits.

Deposit	Borrowing limit at LTV ratio 80%	Borrowing limit at DTI ratio of 4	Purchasing power of buyer
Income = £25,000
£20,000	£80,000	£100,000	£100,000
£25,000	£100,000	£100,000	£125,000
£30,000	£120,000	£100,000	£130,000
Income = £30,000
£20,000	£80,000	£120,000	£100,000
£25,000	£100,000	£120,000	£125,000
£30,000	£120,000	£120,000	£150,000

Why use this regulation?

The Chancellor said that the FPC has been granted these measures “to safeguard the stability of the financial system from any risks posed particularly by the housing market, or banks.” To translate: this is to avoid a housing bubbles that pose a risk to the entire economy.

But these types of policies have the potential to offer so much more than just a safeguard to ensure financial stability. Used more proactively, they can manage housing affordability by limiting growth in lending, thereby ensuring that it moves in-line with incomes and the size of homebuyer deposits. This would help avoid strong increases in house prices, like the one in the lead up to the financial crisis.

The Governor of the Central Bank of Ireland seems to have a similar view. When explaining new mortgage restrictions announced last week, he said that Dublin has a housing problem and “we’re trying to make sure that problem doesn’t get worse”. The Irish Central Bank has introduced LTV ratios of 90% for first time buyers for purchases up to €220,000, with an 80% limit applied for any amounts borrowed above that threshold. A LTV ratio of 80% will apply to second time buyers, and 70% for BTL purchases. These limits will apply to 85-90% of loans issued by lenders.

The stronger limits applied to BTL and second time buyer mortgages will give first time buyers the upper-hand in accessing the property market, by making house prices more affordable and giving them the competitive advantage. This gets around the problem of LTV ratios making it more difficult for first time buyers to get on the property ladder (because they are less likely to have access to enough money for a deposit).

Looking forward

Unfortunately, despite the FPC request to have these regulatory tools over to BTL mortgages as well as owner-occupier loans, the government has not granted these powers over BTL mortgages for now. So if the FPC decide to implement these tools and only have jurisdiction over the owner‑occupier market, this would push home ownership even further out of reach for those that are aspiring to own a home of their own and give buy to let investors the upper hand.

But will the FPC use these tools at all? At what point does a grossly unaffordable housing market become so expensive that these measures are ”necessary to address material financial stability risks”? Why not intervene at an earlier point to improve housing affordability? Lower interest rates could be sustained for longer, helping grow other parts of the economy without deteriorating housing affordability.

Innovative central banks around the world in Ireland, New Zealand, and a number of other countries have led the way in using this regulation. Only time will tell if the Bank of England will join them.