Bank of England’s new mortgage rules aimed at controlling household debt

The Bank of England has unveiled new curbs on mortgage lending designed to avert another explosion of household debt from derailing the economic recovery.

The regulator announced that no more than 15 per cent of new mortgages granted by each commercial bank can be at loan-to-income multiples of 4.5 and above.

Currently just 11 per cent of new mortgages being granted are at such high loan-to-income multiples, so the new restriction will not have any immediate effect on banks’ lending volumes.

The regulator also instructed banks to apply a more stringent affordability test on all new mortgages. Lenders will have to assess whether borrowers will be able to afford repayments if interest rates were to rise from their present record lows of 0.5 per cent to 3.5 per cent over the next five years. Lenders currently test whether borrowers can withstand a rise in interest rates up to 3 per cent, so the move represents only a marginal tightening. The Treasury also confirmed that no mortgages worth more than 4.5 times incomes would be eligible for subsidy under the Government’s Help to Buy scheme.

The Bank’s Governor, Mark Carney, said the moves were not intended to reduce house prices but represented “insurance” against banks stepping up their volumes of risky lending. “It is prudent to insure against these risks,” he said. “Underwriting standards are more responsible than they were in the past. However, we have seen time and again how quickly responsible can turn to reckless”.

Mr Carney said history shows that when UK household debt levels grow excessively, people have a tendency to cut back their expenditure sharply, plunging the economy into recession.

James Knightley, of ING Bank, described the moves as “very modest” and said none addressed the fundamental problem of lack of new housing supply. “The factors supporting the long-term upward move in property prices are unlikely to be tested,” he said. The current average ratio of house prices to incomes is 5.5 times according to the Nationwide building society. London is likely to be hit disproportionately by the new loan-to-income curbs. According to the Council for Mortgage Lenders 19 per cent of new loans in the capital in the first quarter were 4.5 times income or more. In the rest of the country the proportion was 9 per cent.

First-time buyers will also be disproportionately impacted. According to Nationwide, the average ratio of house prices to first-time buyer incomes in the UK was 4.7 in the first quarter of 2014. In London the average house price to earnings ratio for new buyers was eight times.

House prices rose at an annual rate of almost 10 per cent in April, according to the Office for National Statistics, exacerbating fears of a price bubble. House prices in London jumped by 18.7 per cent year on year. But the Bank’s analysis yesterday made it clear it does not see evidence that a house-price bubble is inflating. The Bank’s central expectation is that house prices will continue rising, with prices projected to be 20 per cent higher over the next three years.

The regulator added that the new loan-to-income curbs will not apply to buy-to-let loans. Households that re-mortgage will also not be affected, provided borrowers do not attempt to add to the principal debt when they do so.