In his speech last night to the UCD Economics Society, Governor of the Central Bank Dr. Patrick Honohan touched on a mortgage nerve; he referenced the possibility that the Central Bank is about to take a more proactive role in policing mortgage lending here.
Two areas singled out for special focus were the loan-to-value ratio and the debt-service-ratio. In other words, the amount of deposit one may be required to have when applying for a mortgage and the percentage of income the lender could use when evaluating their overall loan repayment capacity.
The Central Bank needs to tread carefully. While its overall direction is positive, it must ensure that it does not throw the baby out with the bathwater.
Loan-to-value ratios are an interesting beast. In the price ranges where the mass market congregates, it could be counter-productive to set possible deposit requirements too high. For example, if the Central Bank were to set 20% as an absolute, this could punish the financially prudent. For example, those that saved their deposits on their own and paid a significant rent while doing so may actually find it extremely difficult to accumulate 20% in an appreciating market.
Where the Central Bank should focus
In Dr. Honohan’s speech, there seemed to be a significant reference to restricting borrower activity and less focus on restricting lender activity.
Area of possible limits
There are 4 immediate areas where the Central Bank could have a significant market impact while protecting the long-term financial well-being of consumers:
1. Place a cap on lending terms – no loans on residential mortgages should be greater than 30 years. Presently, they are 35 years by the pillar banks.
2. Place a cap on interest rate limits – these should be annual and lifetime caps to protect Standard Variable Rate mortgages holders against excessive increases but sufficient to maintain a profitable margin for banks. These limits would ‘float’ above the ECB base rate.
3. Establish a Jumbo loan criteria and ‘waterfall’ against it with more restrictive lending , including loan-to-value limits of say 65%.
4. End interest-only lending – except as an emergency measure (for example in the case of mortgage arrears.
At the height of the property boom, 37% of all first time buyer mortgages were for 100% finance. Almost one-in-five were over 40-year terms and many first time buyers and property investors began their loan repayments on an interest-only basis, which created ‘artificial affordability’.