CML: The coming debate: lending, consumer choice, aspirations and risk

Most households want to be home-owners, and the government has sought to encourage more widespread owner-occupation.

Lenders have been under pressure to address the issue of financial exclusion, and have developed a range of products addressing the less certain nature of inter-personal relationships, patterns of employment and personal financial status.

Strong income and economic growth – and a shortage of housing supply – has fuelled rapid house price growth. This has created affordability problems for first-time buyers, and lenders have been under pressure to help.

Buy-to-let has helped revive the private rented sector, improving choice for households and reducing the number of young adults taking on significant mortgage debt.

Although the risk profile of mortgage lending has increased, lenders had been experiencing historically low levels of default prior to the credit crunch.

For many years, lenders have worked to make home-ownership more sustainable by seeking to improve support for home-owners in difficulty and promoting better understanding of the risks of borrowing.

The current problems in the housing market stem from unanticipated, protracted and massive disruption of wholesale funding markets. This has affected all lenders, including those who fund most of their lending from retail savings.

The result has been higher borrowing costs and reduced access to mortgage funding. This has triggered weaker housing market conditions.

The co-ordinated measures announced by the tripartite authorities earlier this month represent a concerted and comprehensive plan to restore financial stability.

When stability resumes, stakeholders will – quite rightly – wish to explore ways of reducing risk. Proposals emerging from that debate may have implications for the number and type of households that are able to enter, and sustain, home-ownership.

Lending volumes in 2009

Last week’s intervention by the Treasury to revive the financial sector triggered a debate about how much mortgage lending there should be in 2009. In many ways, it was a microcosm of a more far-reaching debate to come.

Its outcome will have implications for some of the key issues in the UK today – the future scale and scope of home-ownership; consumer aspirations and the extent to which it will be possible to meet them; financial exclusion; and attitudes and exposure to risk, at an individual level, and on a national and global scale.

What launched last week’s discussion about lending volumes in 2009 was the announcement by the Treasury that, as a condition of its scheme to re-capitalise financial institutions, it was seeking a commitment to “maintaining, over the next three years, the availability and active marketing of competitively-priced lending to home-owners and to small businesses at 2007 levels.”

Our view is that it would be neither prudent nor desirable for total mortgage lending to match 2007 levels. The reality is that, given lower house prices and a sharply reduced supply of – and demand for – mortgage finance, such a volume of lending cannot be achieved in any case.

As we said yesterday, gross lending this year is likely to total around £255 billion, compared with £363 billion in 2007. Net lending, meanwhile, is likely to total around £40 billion, compared with £108 billion last year.

Restoring stability

We support the government’s intervention last week and its broader aspiration of promoting financial stability. However, we believe that a more desirable and achievable goal for lending next year would be the restoration of a mortgage market that reflects past conditions in a more general sense – namely a broad and deep market, with a good spread of products and access for credit-worthy borrowers.

To be effective, however, those conditions need to be matched by a willingness to borrow by consumers. This is much less certain at a time of growing economic and individual uncertainty and as we enter a recession.

Government aspirations: less risk – but more home-ownership

As well as a specific target for lending next year, last week’s Treasury statement referred to a range of other “commitments” it was seeking. These include “support for schemes to help people struggling with mortgage payments to stay in their homes, and…support (for) the expansion of financial capability initiatives.”

We are, of course, already working with the government and lenders to ensure that as many people as possible are able to remain in their homes if they suffer temporary financial difficulties. But in referring to measures to improve financial capability, the Treasury statement touched on some of the issues forming part of the broader debate ahead.

Perhaps the key issue in that debate will be the aspirations of the vast majority of households to be home-owners. In the past, the government has recognised this and sought to extend the benefits of home-ownership to more people. Politicians across the political spectrum have been supported by consumer groups in pressing for a more inclusive approach to the expansion of home-ownership, and in a campaign against financial exclusion more generally.

In a foreword to the Barker review in December 2005, the then chancellor and deputy prime minister said:

“We will extend home-ownership towards 75 per cent. We will deliver new and better homes, to support growth and prosperity in every English region. And we will continue to build on our record of success in building affordable homes, bringing quality and choice to those who rent.

“The choice is clear: meet the needs of future generations, or deny them the opportunities we enjoy. Extend the benefits of home-ownership towards 75 per cent of households, or accept that unaffordable housing will constrain our social and economic ambitions. Support affordable housing, or see growing inequalities and disadvantage.”

The key question is: does extending home-ownership towards 75% of the population represent a desirable political aspiration or an unnecessary risk to the electorate? In any case, the reality is, of course, that such a level of home-ownership cannot be achieved in the foreseeable future. Owner-occupation may, in fact, shrink in the near term.

Partly to help achieve these longer term aspirations, however, lenders have developed a range of mortgage products providing options for borrowers in a variety of individual circumstances, and against a backdrop of less certainty about inter-personal relationships, employment and personal financial status.

Financial inclusion and consumer choice

Over time, lenders have provided a wider choice for borrowers. Options include remortgaging, offset and current account mortgages, buy-to-let, self-certified loans, adverse credit products, and lifetime and sharia-compliant mortgages. The provision of this wide range of products has enabled a majority of consumers to tailor their borrowing to become home-owners and to improve their financial circumstances by becoming part of a wider asset-owning democracy.

Lenders have adopted a similar approach to the use of affordability models to assess the size of loan available to a customer. They have allowed lenders to assess debt-servicing capacity on an individual basis, and to selectively ease lending criteria, rather than use the blunt tool of fixed income multiples.

Recently, however, some have called for a return to this type of standardised approach to borrowing decisions as it is seen as less risky. But the fact is that the overwhelming majority of borrowers continue to meet their mortgage commitments in full and on time every month. And a more flexible approach to assessing affordability has presented a wider range of choices and options that the majority of consumers have shown that they are capable of managing successfully.

The plight of first-time buyers has been particularly emotive, with lenders criticised, on the one hand, for easing affordability criteria and, on the other, for not doing enough to help. With house prices having strongly outpaced growth for a long period, lenders have made considerable efforts to support and sustain first-time buyers in the face of intensifying affordability pressures.

The government has understood the change in risk profile in mortgage lending and, in the past, has been challenging lenders and others to go further.

In February 2007, the Department for Communities and Local Government published a report, Social Mobility and Home-Ownership: A Risk Assessment, which acknowledged that higher rates of owner-occupation would inevitably draw in more financially marginal and vulnerable households.

As we enter a downturn, we are now seeing the wider consequences. More borrowers facing long-term unemployment and other financial difficulties are at risk of losing their homes. It is for this reason that we have consistently called for government action to build a more comprehensive safety net of support for home-owners in difficulty.

Once the more pressing and immediate problems of the financial system have been resolved, stakeholders will no doubt re-new the debate about meeting aspirations for home-ownership and managing exposure to risk. Policy and regulatory initiatives will have an impact on the number and types of households that are able to enter – and sustain – home-ownership.

Getting the balance right

While we recognise the strength of aspirations to home-ownership and the many benefits it delivers, we also acknowledge that it is not the tenure for everyone all of the time. The real challenge is deliver a healthy balance of tenures, providing a choice of affordable housing options.

We understand the needs for diversity, and for the balance of tenure to respond to economic and social change. We will continue to seek to work with all political parties and other stakeholders on a long-term policy approach to housing provision and the delivery of tenure choices.

The reality is that lenders already help fund housing across all tenures. In the middle of this year, around 14% (£166 billion) of lenders’ total balances outstanding (£1,211 billion) were secured against properties rented to tenants. Much of this was lending to private landlords, but £33 billion was secured on lending in the social sector. Over many years, the government has drawn on private finance from lenders to help fulfil its social housing obligations.

One response to balancing aspirations to home-ownership with risks for more marginal borrowers may be more widespread availability of an intermediate tenure. In the longer term, we see a potential for expanding low-cost home-ownership and for households to be able to lower or raise their level of home-ownership according to their changing personal circumstances. That would be one way of managing the higher risk profile of mortgage lending as a result of extending home-ownership lower down the socio-economic spectrum.

Tough decisions, tough choices

Looking ahead, the restoration of financial stability remains the over-riding priority at this stage. Once this has been achieved, and a period of transition for the housing and mortgage markets has ended, we anticipate that stakeholders will wish to explore how the risks inherent in financial decision-making and the provision of housing finance can be addressed in a balanced way.

In the UK, the future scale and scope of access to home-ownership, and to housing finance, are issues of national significance. But if a balance is not achieved by providing better support for home-owners in difficulty, there will be inevitable consequences for the size of the lending industry; competition between firms; the cost, availability and variety of mortgage products; the extent of home-ownership; and the role of other housing tenures.