Should the Government get deeper into the mortgage market?

The latest Government loan scheme to help people to buy their first home will likely get a deluge of applications. It offers interest rates way below those available in the market. This raises two questions. Should the Government be doing this ? And if it can offer mortgages on these terms, why can’t the banks?

Under the Central Bank rules loans are capped at 3.5 times the income of borrowers , while the new scheme will offer loans in some cases up to 5 times income.

Key problems

The scheme,effectively a more attractive revamp of the current local authority home loan scheme, is designed to address a key problem the market, which is that the rules as currently constructed make it difficult, or in many cases impossible, for lower income first-time buyers to afford to buy a home. House-price inflation, driven by the supply shortage in the market, has moved properties out of the reach of many.

The Central Bank rules do allow some exceptions to the 3.5 times rules, but many who want to enter the market are still finding themselves locked out.

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The new scheme does raise some questions. Potential borrowers must have have had two refusals from banks of the required amount. To allow these people to buy,should the State be lending at income multiples above the Central Bank rules ?

The rationale given is that because the loans are offered at low interest rates – rates of 2 to 2.5 per cent fixed for the length of the mortgage – it can still be affordable for the borrower. Loans are to be capped so that repayments cannot be more than one third of monthly disposable income.

It would be interesting to hear a view from the Central Bank on what the rules mean for the borrower in the long term. Does it risk helping people to buy properties they can’t afford? What is the risk if prices fall?

The low interest rates and stability are clearly a plus, though one issue could be whether a borrower buying a property on these terms could then afford to trade up in the years ahead, presumably then reliant on remortgaging via a normal bank loan.

For the State, the fact that these borrowers have been turned down by the banks means that, in some cases at least, the State – via this local authority scheme will be taking on higher risk borrowers. The current local authority schemes have not done much lending in recent years, but do have sizeable histocial arrears.

Also, like the help-to-buy scheme, which offers a tax refund for first-time buyers, this scheme could add further to demand in the market, potentially pricing out some who do have bank approval.

More supply

The only long-term answer here is more supply. The Government is acting on this, too, but more supply takes time. The question is whether the new scheme will add further unwelcome impetus to rising prices in the short term. In terms of the interest rate offered, the Government can certainly raise money at lower rates at the moment, but is unlikely to be able to do so over the long term, as interest rate markets normalise. A fixed rate of 2.5 per cent or less could look like a very good deal for the borrower in five years time.

Another important question is whether the State intends to retain ownership of the mortgages in the long-term, or sell on the loan book to free cash for further financing. And if the State does retain control, how will it deal with arrears and ensure there is not an incentive to default?

The scheme is modest in size, though it could expand in time and the Minister is also moving ahead with another scheme where people can buy in partnership with the State, another way of closing the gap for those who are currently priced out. The State is slowly becoming a bigger player on both sides of the market.

There is one final irony here. The latest scheme is needed, in part, because banks here still charge too much for mortgages. Value has improved a bit, but margins are still too high. And the concept of fixing a mortgage repayment for the entire time makes sense, provided banks can come up with funding models to support it, but is not generally on offer commercially.

The competitive response of banks – centred on cash-back offers and the like – has largely been disappointing over the past few years. More supply and a better functioning banking sector would do a lot more for the housing market than any number of Government schemes.