Housing Debt Bulge as Wages Shrink Hurts U.K.: Mortgages

FSR Loan to Income

Aug. 15 (Bloomberg) -- U.K. homebuyers are taking bigger mortgages for longer periods than they did before the financial crisis six years ago, making them more vulnerable to defaults after borrowing costs rise.

They are burdening themselves with more debt as household earnings sag. Wages fell for the first time in more than five years in the second quarter, dropping 0.2 percent from a year earlier, according to data released this week by the national statistics office.

“This is kind of scary -- these people have stretched themselves to the hilt,” said David Blanchflower, a former Bank of England Monetary Policy Committee member and now an economics professor at Dartmouth College in Hanover, New Hampshire. “The fix is to have wage growth, which isn’t going to happen, and then their payments are going to go up and we’re going to see defaults go through the roof.”

Homebuyers are paying record prices even as wages decline. U.K. home values grew to an all-time high of 270,636 pounds ($452,000) on average in July, about 10 percent more than a year earlier, as sales reached the highest in seven years, researcher Acadata said in an Aug. 8 report. A rise in interest rates, which have been at a record low since March 2009, would put house prices at risk of a “sharp” fall and jeopardize the economy, the European Union has said.

First-time buyers, helped by looser lending practices, have partly fueled the price gains. The U.K. government’s Help-to-Buy program enables purchasers to take out a loan with a down payment of as little as 5 percent on homes valued at as much as 600,000 pounds.

Lending Rises

Gross mortgage lending rose 20 percent in June to 17.9 billion pounds from a year earlier, the biggest increase since October, according to the BOE. The number of mortgages to first-time buyers jumped by about 19 percent and they borrowed 4.2 billion pounds, a 27 percent increase, according to data compiled by the Council of Mortgage Lenders, a trade group.

Britons are also getting bigger loans on average, according to CML data. And they are holding the debt for a longer time, adding to their risk of default.

About a quarter of new mortgages last year were for 30 years or more compared with 15 percent in 2007, according to data compiled by the central bank. First-time-buyers who borrow more than 4.5 times their annual income get loans maturing on average in more than 30 years. That compares with 27 years in 2005.

Longer-term borrowers may be less able to extend the length of their mortgage to reduce their monthly costs if they get into payment difficulties, according to the central bank’s financial stability report in June.

Recovery Threat

BOE Governor Mark Carney said in May that surging house prices pose the greatest threat to Britain’s recovery. Carney introduced measures in June to curb a buildup of housing debt. Lenders are required to limit the proportion of mortgages at 4.5 times a borrower’s income to no more than 15 percent of their new loans. Banks must also decline loans to those who fail a new stress test that assumes an immediate 3 percentage-point increase in the benchmark rate.

“The increase in house prices in the past year means we can expect the proportion of high loan-to-income mortgages to grow further in the coming year even if the housing market begins to slow,” Carney said in a June 12 speech. “A durable expansion requires mortgages to be serviceable over their lifetime not just when interest rates are at record lows.”

The housing market is showing signs of cooling. An index of prices in London dropped to 10 from 30 in June, the Royal Institution of Chartered Surveyors said yesterday. That’s the lowest since March 2011.

Risky Lending

Policy makers are trying to thwart the kind of risky lending practices that sparked the 2008 financial crisis, spotlighted by the collapse of mortgage lender Northern Rock Plc and the 45.5 billion-pound government bailout of Royal Bank of Scotland Group Plc.

“I don’t think lenders are particularly concerned about future restructuring at present, although they arguably should be concerned about the prospect of increasing interest rates,” Paul Langley, a researcher at England’s Durham University who studies mortgage markets and the global financial crisis, said by e-mail.

Low interest rates mean the number of people behind on their mortgage payments is at the lowest since the first quarter of 2008, the CML said yesterday. There will be 25,000 repossessions this year, 3,000 fewer than last year, the trade group forecast.

Healthy Sign

Some real estate executives view the increase in high loan-to-value mortgages as a sign of economic health. Richard Sexton, a director at property appraiser e.surv, said it shows increasing lender confidence rather than a cause for concern. One in five mortgages were to high loan-to-value borrowers in June, compared with one in nine a year before, as the numbers of first-time buyers grows, he said in a statement.

“Before the financial crash, there were four times as many high loan-to-value loans as there are now,” Sexton said.

In Singapore, the government’s lending curbs and taxes on purchases to prevent a housing bubble have damped prices and sales. The restrictions are stopping Singaporeans from selling their publicly financed homes and moving to newer condos with more amenities. Vishnu Varathan, an economist at Mizuho Bank Ltd., said the government action is reducing risk to the housing market from an impending rate hike.

Surging Debts

Household debt in Britain stood at a record 1.45 trillion pounds in June, according to the BOE, after home values surged. Indebtedness, at about 140 percent of gross disposable income, is higher than in the U.S., Germany, France and Japan.

More than two thirds of U.K. mortgages are tied to the BOE benchmark, which means a jump in rates will boost house payments and put some borrowers at risk of default.

“When it comes to their finances there are many people teetering on a knife edge and rate rises could easily push them over,” Jonathan Harris, a director of mortgage broker Anderson Harris Ltd., said in a statement. “Any rise in interest rates must be gradual and we welcome indications from the Bank of England that this will be the case.”

The U.K. has recovered the output lost during the financial crisis and is on track to be the best-performing Group of Seven economy this year, with the BOE predicting growth of 3.5 percent.

Carney said on Aug. 13 that officials won’t rush to raise rates and that increases would be “gradual and limited.” He highlighted overseas risks to Britain’s recovery and this week’s drop in wages. The bank’s Monetary Policy Committee left interest rates unchanged at a record low 0.5 percent on Aug. 7.

If borrowing costs rise, Dartmouth’s Blanchflower said, “it’s going to impact the housing market hugely.”

To contact the reporter on this story: Neil Callanan in London at ncallanan@bloomberg.net

To contact the editors responsible for this story: Vincent Bielski at vbielski@bloomberg.net; Andrew Blackman at ablackman@bloomberg.net Jeffrey St.Onge, Vincent Bielski, Andrew Blackman