What’s wrong with 100% mortgages?
As a 2004 university entrant, I paid £1,000 annually for tuition fees. Through no skill other than being born earlier than today’s graduates, I managed to avoid entering the job market laden with debt. It feels as though the property market reflects a similar unfairness — if you happened to buy pretty much anytime in the last 25 years, you’ve probably done very well out of it — prices have risen over 350% since 1992, and over the last few years it’s not uncommon for homeowners in London to have earned more from their property price appreciation than from their employment. I therefore understand the sentiment that mortgage lending should be relaxed to give today’s generation of aspiring first time buyers the same opportunity — the post crisis restrictions in mortgage lending are often blamed in exacerbating today’s housing affordability crisis.
In a recent article, the Telegraph cites “Lenders, brokers, academics and other property commentators” in “growing calls for Britain’s financial watchdogs to relax aspects of the post-crisis regulations and allow the resumption of controversial ‘100pc mortgages’”.
Clearly some of these calls are little more than an expression of vested interests. Nevertheless the argument used to justify high loan-to-value mortgages follows the line that
“[if] borrowers can afford monthly repayments, with a risk of interest rate rises factored in, why is it a problem?”.
Of course, in a world where house prices can only go up, this logic holds. Unfortunately, in the real world it fails miserably. It fails both on an individual basis as well as on macro considerations. Clearly the risk for the individual borrower is that they are dangerously close to a situation of negative equity (where the value of their home is less than the outstanding mortgage debt) — any fall in house prices quickly wipes out their wealth in the property and, if they can’t continue making mortgage payments, could leave them with no home and no wealth to fallback on.
On a macro scale, the argument is equally dangerous. To have home buyers in a position of negative equity is inherently bad. As Atif Mian and Amir Sufi persuasively demonstrate in House of Debt, in the US the initial reduction in household spending through the financial crisis was largely driven by the deterioration of household balance sheets, in other words people who had suddenly lost all or nearly all their wealth, quite understandably, no longer had the confidence or ability to continue spending. This led to a vicious cycle of reduced incomes, forced selling of properties, and a deepening crash in the housing market.
So how should we balance this reality with the homeownership aspirations of a generation stuck renting? There’s no single answer to that question, but one conceptual approach that could be helpful is to bifurcate the lifestyle and community benefits of homeownership from financial benefits of price appreciation.
Mortgages as a tool to take leveraged bets on property price appreciations cannot be beaten, but that cannot be the goal today’s aspirational home buyers. The ‘softer’ benefits of homeownership — security of housing and planting long term roots within a community, can be. In this respect there exists a tool already; as David Miles, who served on the MPC from 2009 to 2015, summarises, the
“Help to Buy system which allows people to take out part of a loan to finance a house purchase, the repayment of which is linked to what happens to the value of the property… is wholly helpful — it is a rather strange world we live in where people borrow vast amounts to become homeowners, and the amount we borrow is not linked in any way to what happens to the value of the property”.
This type of arrangement is where the focus of financial practitioners should be — home buyers can enjoy the lifestyle benefits of ownership, but the risk of property price movements is shared between the lender and the buyer, thus dramatically reducing the chances of negative equity. Whilst the specific implementation of Help to Buy sometimes attracts criticism by effectively subsidising house-builders, in no way does this detract from the underlying soundness of making home finance more equity-like, and the benefits that could be derived from a greater availability of such financing.