The risky loans that helped cause the U.K.’s real-estate crash are making a comeback as cash buyers from abroad limit lending opportunities in London and banks instead venture into the weakest markets.
Five years after Royal Bank of Scotland Group Plc and Lloyds Banking Group Plc, the U.K.’s biggest mortgage lender, were bailed out by the government, the number of mortgages with down payments of 15 percent or less rose almost 50 percent in August from a year earlier. In London, where prices are rising fastest, only 1 in 25 borrowers took out a low down-payment loan. In the north of England, the country’s most volatile housing market, it’s about one in five, according to property appraisal firm e.surv Ltd.
High loan-to-value lending is poised to grow as Prime Minister David Cameron’s government this week introduces mortgage guarantees designed to allow people to buy a home costing as much as 600,000 pounds ($963,000) with a down payment as low as 5 percent. That increases the risk of a borrowers’ home value falling below the amount they owe if prices fall, or that they could default if interest rates rise.
“The U.K. banks are already sitting on mortgage lending that exposes them to great interest-rate risk and default risk,” according to Ismail Erturk, a senior lecturer on banking at Manchester Business School. “Current government policy of Help to Buy, as well as quantitative easing by the Bank of England, make things worse because they both encourage banks to lend to an overvalued market.”
Cameron made reviving housing a centerpiece of his government’s economic policy with the introduction of the Help to Buy program this year. The proposal has drawn a warning from the International Monetary Fund for its potential to stoke home price inflation, and been described as “moronic” by Societe Generale SA global strategist Albert Edwards for encouraging Britons to add to already high debt levels.
The first phase, interest-free loans for buyers of newly built homes, began in April and has already contributed to the strongest housing market since the financial crisis.
The second allows applications for mortgage guarantees to begin this week. Borrowers will only require a 5 percent deposit because as much as 15 percent of the purchase price will be jointly guaranteed by the lenders and the government. The guarantee is valid for seven years and lenders have to pay the government a fee for each mortgage it includes.
“There will be tough checks to make sure buyers can afford their mortgage payments and the borrowers income will be verified,” the U.K. Treasury said in a Sept. 29 statement. The guarantee will be available to lenders until January 2017 and the government probably will cap its liability at 12 billion pounds, according to a March filing by the Treasury.
“These mortgages may well be affordable now, but interest rates have to go up at some point and peoples’ circumstances could change,” said Rob Wood, chief U.K. economist for Berenberg Bank. It potentially increases the volatility of the market as and when this scheme is taken away and increases the risks people are taking, he said. “The market is recovering anyway. It doesn’t make any sense to have it recovering any faster than it already is,” he said.
U.K. lenders are already targeting the weakest housing markets with riskier loans because the London market is dominated by cash buyers. About 35 percent of homes bought in the U.K. this year were paid for entirely with cash, according to data compiled by broker Savills Plc. In London, it’s as many as 60 percent, with demand driven by purchasers from abroad who view the city as a haven, according to Richard Sexton, a director at e.surv, a unit of LSL Property Services Plc.
“The London market is like a different country almost,” Sexton said. “That’s a lot of foreign cash coming in.”
Gareth Hill, a spokesman for the Council of Mortgage Lenders, a trade association, declined to comment. Spokesmen for RBS, Lloyds and the U.K. Treasury didn’t reply to calls and e-mails seeking comment.
For the rest of the country, national price gains have been fueled by the Funding for Lending program that allows banks and building societies to borrow from the Bank of England at low rates if they use the cash to fund residential mortgages. That helped boost U.K. mortgage approvals to the highest in more than five years in August, according to the Bank of England.
The aid also pushed home values 0.3 percent higher in September from August to the highest level since September 2008, according to an Oct. 3 report by Halifax, the mortgage unit of Lloyds. U.K. house prices fell 17 percent from their peak in 2007 to their trough in 2009, according to Capital Economics.
Housing is helping to fuel the U.K. recovery as tax income rose and the government cut spending in the year through August from a year earlier. Gross domestic product rose by 0.7 percent in the second quarter, with builders, manufacturers and services firms all reporting the strongest growth in years. The Bloomberg U.K. Homebuilder Index climbed 36 percent this year compared with a 10 percent advance for the FTSE 350 Index.
London has disproportionately benefitted. Traditionally, home prices in England rise first in the capital city and over time they tended to catch up in the north, according to Scott Orford, a lecturer at Cardiff University who studies the U.K. housing market. However, “in the last 10 years, and particularly since the housing market crash, there has been more disjoint,” he said. “The north doesn’t seem to be catching up at all.”
The north of England, defined as Northwest England, North East & Cumbria and Yorkshire, has suffered economically since its decline as an industrial center after World War II. Incomes and earnings power are lower in the north, said Ed Ferrari, a lecturer at the University of Sheffield who has studied the U.K.’s housing-market volatility.
“The north has the land to develop housing. What it doesn’t have is demand for that housing,” he said. The government should focus on improving housing supply rather than demand, Ferrari said.
In Liverpool, the council offered 20 dilapidated homes for sale for 1 pound each in February. More than 1,000 people applied to buy the properties, according to the council’s website.
About 9 percent of borrowers in the north were in negative equity in the first quarter of this year, up from 8.5 percent in the fourth quarter of 2011, Standard & Poor’s analysts including Mark Boyce wrote in a June 19 report. That compares with an estimated 2 percent of homeowners in the south whose properties are worth less than they owe on their mortgages, S&P estimates.
The region may also be hurt by the government’s plan to fire 1.2 million workers from 2011 through the first quarter of 2018, because a higher proportion of their employees work there, S&P said. S&P defines the north as the Midlands, North East and North West of England, Yorkshire and the Humber, Wales and Scotland.
Lloyds fell 1.1 percent to 74.12 pence at 4:34 p.m. in London, the biggest decline among the six stocks in the FTSE 350 Banks Index, which dropped 0.5 percent.
Sexton of e.surv doesn’t expect high loan-to-value mortgages to be as prevalent as they were in 2007, when almost 15 percent of all mortgages were made at an LTV of 90 percent or more, according to the Prudential Regulation Authority.
“It’s a long way from that level and I wouldn’t endorse it reaching that level again because I’m not sure that’s sustainable,” he said. About 11.8 percent of mortgages had an LTV of 85 percent or more in August, according to e.surv’s data.
The new “guarantee will support an increase in high loan-to-value mortgages for people who can’t afford large deposits, and it will also boost house building,” Chancellor of the Exchequer George Osborne said in a July statement.
Still, Help to Buy “is a risk that’s not worth taking,” said Berenberg’s Wood. “It will mainly result in higher house-price inflation, which is close to repeating the mistakes of the past.”