U.K. Resurrecting Loans for 95% of Value Seen as Risky

When James Seabury found his first home in northeast England in November, he had to borrow almost all of the 140,500-pound ($236,000) purchase price.

“Seven thousand pounds was all we had for a deposit,” said Seabury, 30, a town planner whose loan covered 95 percent of the purchase price. “We managed to get the mortgage sorted and move in within four or five months. It was really quick.”

With U.K. home prices rising at the fastest pace since 2010, banks are making more high loan-to-value mortgages. The number of loan products available to borrowers with a 5 percent deposit has tripled to 132 since the government in October extended its Help-to-Buy program, which assists buyers with down payments on new homes, according to Genworth Financial Inc.

These higher risk loans are similar to those that spurred the U.K.’s property crash in 2008, when the country’s biggest mortgage lender, Northern Rock Plc, collapsed, and home prices fell 17 percent. Today, with just 5 percent down, borrowers may later find themselves underwater, owing more on their properties than they are worth, said Rob Wood, a former Bank of England economist.

“Small falls in house prices can push them into negative equity,” said Wood, who works at Berenberg Bank in London.

Prime Minister David Cameron’s support for homebuyers is boosting the economy before next year’s national elections. Help to Buy allows purchasers to take out a mortgage with a down payment of as little as 5 percent for a home costing as much as 600,000 pounds. Britain’s economy will expand by 2.9 percent this year, the most since 2007, the International Monetary Fund said on April 8.

’Bad Policy’

Willem Buiter, an external member of the BOE’s rate-setting committee from 1997 to 2000, said earlier this month that encouraging people to take out higher loan-to-value mortgages is bad policy and the market is overheating.

“If it’s a bubble, we’ll be able to tell after it pops,” he said at a briefing in London. “If it isn’t one, it sure looks like one.”

Mortgages worth 95 percent of a home’s value were the only type to grow in popularity in the first two months of the year, according to Genworth. As a result, the number of mortgages with deposits of 15 percent or less topped 11,000 for the first time in almost six years in February, according to data compiled by LSL Property Services Plc’s surveying unit.

Royal Bank of Scotland Plc, Banco Santander SA, HSBC Holdings Plc and Barclays Plc offer high loan-to-value mortgages through the government’s Help-to-Buy program.

RBS Bailout

RBS was bailed out by the U.K. government, posting a loss of about 24 billion pounds in 2008, the biggest in U.K. corporate history, because of bad loans, investments in mortgage-backed securities and ill-timed acquisitions. The U.K. still owns 80 percent of the bank.

The government’s stimulus “has not been the fuel to house prices that the parliamentary critics thought it would be,” Chancellor of the Exchequer George Osborne told lawmakers on the Treasury Select Committee on April 3. He said that three-quarters of the homes bought using the program were outside London and southeast England.

“Ultimately, I want to live in a country where people who have the aspiration and can afford to buy their own home are able to do so,” Osborne said.

Record-low borrowing costs and government loan guarantees pushed up house prices 9.1 percent in the year through February, according to the Office for National Statistics. A typical first-time buyer borrowed 3.33 times their annual income for a home in 2013, according to the Council for Mortgage Lenders. That’s the most since 2007.

Short-Term Benefits

Gains have been led by London, where values rose by the most since 2007 during the year through February, according to the statistics office. Prices are showing “considerable momentum,” especially in the capital, the BOE said yesterday.

The average home in the city now costs eight times the average first-time buyer’s salary, according to mortgage lender Nationwide Building Society.

“The government has acted to deal with what they perceived to be a missing market” in higher loan-to-value mortgages, said Sam Hill, senior U.K. economist at Royal Bank of Canada in London. Because the number and proportion of mortgages ending in repossession is lower in 2013 than in any year since 2007, Hill said government policy has produced short-term benefits, such as helping the economy rebound from a recession.

“The pickup in activity in the housing market has been good for the economy, because of the activity it’s spurred,” Hill said. “But there’s a risk in letting it go on too long.”

Underwriting Standards

Mortgage approvals were close to a six-year high at 70,309 in February, according to BOE data, though still well below their 2003 peak of more than 132,000.

Construction companies have been among those to gain from the booming market, with the Bloomberg U.K. Homebuilder Index of 10 stocks advancing about 17 percent in the past year.

“It’s obviously not a sufficiently pressing problem at the moment,” said Ross Walker, an economist at RBS in London. “U.K. housing is still cheaper than it has been in recent years” and “you’d be hard pressed to say that today’s lending will create problems down the line.”

The U.K. markets regulator warned last month that the rapid growth in house prices could lead lenders to weaken underwriting standards to maintain market share. Banks could start to “accept a higher proportion of bonus payments, commission or income from second jobs to stretch affordability assessments,” the Financial Conduct Authority said.

Northern Rock

During the financial crisis, the government nationalized companies including Northern Rock after their lending practices led to huge losses. Newcastle, England-based Northern Rock canceled a program that let customers borrow as much as 125 percent of their homes’ value, and Lloyds TSB Group Plc’s Cheltenham & Gloucester building-society unit ended mortgages to buyers with down payments of less than 10 percent.

Regulators are only now responding to the real estate crisis of 2008 with an affordability test set to debut this month, after a three-year review. The Mortgage Market Review test requires borrowers to prove they can afford to make mortgage payments, even when interest rates rise in line with market expectations. And the BOE may be able to make the tests more stringent by applying higher hypothetical borrowing costs.

“You could see a spike in interest rates higher than is currently embedded in the market in the U.K., and we’d want to make sure that, as banks and building societies lend -- and very importantly, as households borrow -- they can withstand those shocks,” BOE Governor Mark Carney told reporters when the measure was announced in November.

Unemployment Drops

U.K. mortgages tend to have fixed rates for three to five years. If the BOE increases the base rate within that period, borrowers must then choose to move to a variable rate or a more expensive fixed-rate mortgage.

U.K. unemployment dropped to a five-year low of 6.9 percent in February, underscoring the recovery’s strength and raising the prospect of a debate among BOE officials about raising interest rates. The first interest rate increase since March 2009 will come next April, according to one-month forward contracts for the sterling overnight interbank average, or Sonia.

Borrowing costs on home loans fell as the BOE kept its key rate at a record low. The average rate charged on a two-year fixed-rate mortgage with a 90 percent loan-to-value ratio was 4.38 percent in March, down from 6.61 percent in March 2010, BOE data show.

Seabury, the town planner who bought a home in Sunderland, which was once the largest shipbuilding town in the world, is already thinking about interest rates. The fixed-rate term on his loan from Yorkshire Bank Plc will expire in three years, when he may face higher mortgage costs.

“We’ll just have to see how we go,” he said. “The way things are going, I wouldn’t have agreed to a fixed-rate mortgage for any less than three years.”