Select Committee on Office of the Deputy Prime Minister: Housing, Planning, Local Government and the Regions Written Evidence

Memorandum by the Council of Mortgage Lenders (CML) (AH 37)


  1.  The Council of Mortgage Lenders (CML) welcomes this opportunity to submit evidence to the Select Committee. Affordability and the supply of new homes are matters of great importance to the industry, households and indeed the country as a whole.

  2.  The CML is the representative trade body for the mortgage lending industry in the UK. We have 147 members who together lend around 98% of the residential mortgages outstanding. The industry provides funding to support home-ownership, the private rented sector (including buy-to-let) and the social rented sector.

  3.  The CML devotes considerable resources to tracking and analysing the UK's housing and mortgage markets and works with lenders and others to develop products and procedures that can reduce the risks homeowners face. Every six months the CML publishes housing market forecasts, a repossession risk review and detailed arrears and possessions figures. The CML also commissions research on specific topics such as first-time buyers and regularly publishes articles through Housing Finance Online. Since 1999, the CML has been working with the Government on the Sustainable Home Ownership initiative through which work has been undertaken to improve both the public and private safety nets for homebuyers in difficulty. More recently, the CML has been working with the Government on equity loans and how more use might be made of these to help low income home-owners.

  4.  Work with the Government is important but it is vital that this should be seen in perspective. The UK mortgage lending industry makes mortgage loans totalling around £100 billion net every year (ie, total loans made minus loans repaid). The UK industry offers a wide variety of products covering a range of sub-markets and is judged by independent reviewers to be not only the largest but also the most competitive and innovative mortgage market in Europe (Mercer Oliver Wyman, 2003).

  5.  We have structured our response around the issues set out in your Press Notice. Our assessment of these suggested they might be clustered into three areas, home-ownership, affordability and house prices and housing supply. The response follows this logic.


  6.  The main points raised in this submission are as follows:

    —  Lenders have been actively working to assist the access to and the sustainability of home ownership. An innovative and flexible range of mortgage products designed to achieve this are on offer, where this can be done on a prudent and sustainable basis.

    —  The housing market remains strong, but potential first-time buyers face significant affordability hurdles—some of these pressures are cyclical (and an important part of orderly transition of housing market to a soft landing), but there is also evidence of problems becoming structural.

    —  A key problem and the focus of Barker Review is the UK's chronic under-investment in house-building.

    —  Potential exists for all tenures to grow in absolute terms, although social housing is likely to diminish in relative importance. Emergence of intermediate tenure is important for overall efficiency of housing market and broader sharing of welfare benefits that come from asset ownership.

    —  The sustainability of home-ownership is a more important issue than any specific target level. There is an unmet demand for home-ownership and around 80% of households will probably be home-owners at some point in the life cycle.

    —  There are no simple solutions to tackling affordability and housing supply—and clear limits to what government can deliver. There are some useful Government initiatives, eg, low cost home ownership (LCHO), but also less helpful interventions, eg, Stamp Duty. There is also the possibility of some unintended outcomes if the Barker Review process succeeds, eg, lower risk appetite from lenders and less ability to tailor products aimed at LCHO.


  7.  The mortgage lending industry has been a strong supporter of home-ownership. The industry has long argued that the benefits of owner-occupation are many and varied including the degree of control and security it offers households over their homes and the financial advantages of acquiring a property (ceasing to pay rent and building a financial asset). This is evident in surveys of tenure preferences. Although it has fluctuated over time there is still an unfulfilled demand in relation to home-ownership (see Chart 1). This is despite the reductions in tax benefits, eg, the withdrawal of mortgage interest tax relief in 2000 and it is now the case that the tax take from home-ownership via stamp duty and other taxes now exceeds capital gains tax relief (Wilcox, 2004 ). As has been evident from the Government's own reviews (HMT and ODPM, 2005), home-ownership is perceived to act as a significant stimulus to the economy (though see paragraph 27) both through spending on home improvements and furnishings, the feel good factor and the wealth effects of house price inflation.

  8.  Although the advantages of home-ownership are many and considerable it is not without its critics (eg, Malpass, 2005). There are concerns about the over-promotion of the tenure, the difficulties households may have in moving between areas and the effects of any house price depression on both households, regions and indeed the economy as a whole. Certainly one cannot ignore the difficulties posed by the last major housing downturn (1991-93), for example the 200,000 households who lost their homes through repossession during this period, but the reality was that the vast majority of households continued to service their mortgage debts and the home-ownership market withstood a major test of its underlying strength. Although there have been suggestions the UK is on the verge of another major house price depression (Capital Economics, 2004) the consensus view now seems to be we are seeing a slow downward adjustment and should arrive at the so called, "soft landing" with prices adjusting to the underlying capacity of households to buy.

  9.  Like many others, the CML is concerned about the sustained decline in the number and proportion of first-time buyers. However, lenders do not feel this should be dealt with simply by lending households more money. Indeed, it is evident both they and borrowers have been acting prudently in terms of borrowing. The number of 95% plus loans is substantially less than in the late 1980s (see Chart 2). As we discuss later, lenders have sought to help potential buyers with new products and alongside this they have introduced efficiencies related to the conveyancing process by agreeing a standardised set of solicitors instructions (the lenders handbook), dealt with the incidence of defective new homes (through lenders agreeing not to release the mortgage until property was certified as properly completed) and increasingly no longer levying the higher lending charge fee (for loans above 85% where a mortgage indemnity policy must be bought). In addition, reflecting the highly competitive market, lenders commonly offer free valuations and legal work.

  10.  The CML is of the view that it will be possible to expand home-ownership further albeit this growth will be slow and possibly limited in terms of the UK total. The UK is 13th in the EU home-ownership league table. With low interest rates and rising wages modest growth should be possible. Demographically driven growth will take place anyway as older generations of tenants are replaced by younger home owning households. We do not have a view as to how big the home-ownership sector should be as this is largely a product of market circumstances, government support and household preferences

  11.  The CML's recent work on equity loans demonstrates lenders' interest in broadening the ways in which households can acquire, hold and dispose of housing equity. The recent report by Wilcox (2005) illustrates that there is potential for developing an intermediate housing tenure, although being based on secondary analysis it does not actually take into account household preferences. As our first-time buyer research indicated (CML, 2005a), many young households are happy to rent privately until they are ready to settle down in their early-to-mid 30s. The key factor affecting the scale and future role for intermediate housing solutions is likely to be the proportion of such households that have ultimately aspirations to achieve full home-ownership in the future. At the same time, as was evident from the Government's Home Ownership Task Force (HOTF, 2003), there was some real concern that the intermediate home-ownership sector was not being supported or managed appropriately and that change was needed to help it meet its full potential.

  12.  Although numerical growth is possible in all tenures, given the growth in households and people, it is clear that if home-ownership is to grow in proportionate terms then one of the other tenures must be reduced. Given the recent and welcome growth in the private rented sector, it is our view that the social rented sector will ultimately shrink further. This will be reflect increased wealth and prosperity across society in the UK.

  13.  Our recent research (CML, 2005) suggested that, using one measure, we might see between 1.8 and 2.2 million new first-time buyers over the 2006-10 period. Although this is likely to include a substantial proportion of households (around 20%) who are returning to home-ownership, it does indicate that further growth of the tenure is possible, in both absolute terms and relative to other tenures. Moreover, the lower numbers of first-time buyers seen since 2003 coupled with the demographic profile suggests that there is a growing pool of potential first-time buyers who may be delaying purchase for lifestyle reasons or concerns about affordability.


  14.  The future course of home-ownership will be heavily influenced by its affordability. Pressure on affordability increased through much of 2004. In summary;

    —  House prices rose nationally to hit new peaks; the average UK house price is now more than £186,000.

    —  The ratios of house prices to earnings and other measures of income are at record high levels

    —  Mortgage payments as a percentage of income for first-time buyers have risen sharply over the past year or so and are now close to the problematic levels of the early 1990s.

  15.  Affordability is now improving modestly as house price growth has fallen below income growth and variable and fixed-term interest rates are lower than at the beginning of the year. However, affordability has deteriorated in all UK regions in recent years. The least affordable regions are the south west, Greater London and the south east and the most affordable regions are the three north of England regions plus Scotland and Northern Ireland.

  16.  As noted earlier affordability pressures have become a serious problem for first-time buyers with increasing numbers currently unable to access home-ownership. The number of first-time buyers has shrunk to around 330,000 a year (30% of total) from around 550,000 (45% of total) at the turn of the decade. The gap between what lenders are willing to lend based on ability to repay assessments and the price of property has widened.

  17.  To access the market, increasing numbers of first-time buyers are having to provide large deposits. For a typical first-time buyer this is now around £17,000, equivalent to over 50% of gross annual household income. This compares with a little over 25% of annual income five years ago. In the least affordable regions, the typical deposit is now equivalent to 65% of annual household income. First-time buyers are increasingly seeking assistance to raise deposits. The Financial Times (FT, 2005) recently reported on a survey which indicated that up to 50% currently receive assistance from parents compared with 30% three years ago. ODPM figures show that nearly a quarter of first-time buyers rely on gifts and family loans to afford a deposit compared with 4% 25 years ago.

  18.  There is a limit to how much assistance can be given. The figures only record those who actually become home-owners. Those without assistance may be forced to defer or reconsider home ownership as an option. Wilcox's recently developed measure of affordability (Wilcox, 2005)—the number of households aged under-40 in Great Britain, whose income would be too high to qualify for housing benefit if they were living in social rented accommodation, but too low to afford a mortgage on the cheapest 10% of two- or three-bedroom homes for sale in their area—probably overstates (by a large margin) the actual demand-based figure. A more appropriate measure might be the number of households who currently want to become home-owners and would meet all other underwriting criteria for a mortgage, but who, because of prevailing house prices, interest rates and income levels, fail lenders' ability to repay assessments.


  19.  In terms of the market as a whole the increasing choice of fixed, variable and capped rate products allows borrowers to choose the risks they want to bear. Some products allow higher income multiples against longer-term fixed rate products which protect younger (first-time) borrowers from interest rate re-pricing risk for the duration of the loan. Increasing optionality built into products such as payment holidays, additional borrowing facilities and offset mortgages. These products provide greater flexibility (at a cost), and may support short-term sustainability rather than immediate affordability.

  20.  Competitive pressures within the mortgage lending industry have resulted in a structural narrowing in lending margins relative to base rates over many years. This benefits all borrowers. With respect to first-time buyers, examples of products designed specifically to help them into home-ownership include:

    —  Low equity/high LTV loans typically allowing up to 95% to be borrowed. Some lenders offer more than 100% through a combined mortgage and unsecured loan.

    —  Guarantor mortgages, where the guarantor assumes responsibility for repaying the loan in the event of default by the borrower.

    —  Joint loans between parents and children.

    —  Mortgages based on the incomes of more than two applicants.

    —  Family offset products where interest earned on the savings or current accounts of family members can be used to offset the mortgage payments of the borrower.

  21.  Alongside such product innovation we must also note the rise of the market for re-mortgaging in recent years allowing borrowers to take advantage of more favourable market interest rates, reducing (or limiting rises in) mortgage service costs. This allows for rapid adjustments once a household has entered the tenure.

  22.  The lower and more stable level of interest rates than in the past means that borrowers can borrow more relative to income for a given level of monthly debt service. Reflecting this (and the spur given by Mortgage Conduct of Business MCOB responsible lending requirements), lender underwriting processes are increasingly based on a close individual assessment of ability to repay rather than crude income multiples. This is an area of active development and debate. Increasingly sophisticated ability to repay models take account of:

    —  Income prospects as well as current income.

    —  Disposable income rather than gross income.

    —  Differences in family size and composition.

    —  Lifestyle and spending patterns.

    —  Other financial commitments.

    —  Ability to repay if interest rates rise.

  23.  It has been possible for lenders to extend high income multiple loans on a tailored and prudent basis, helping aspiring home-owners to enter the market. In addition, in recent years, lenders have also been offering mortgage finance to previously "underserved" parts of the market including the self-employed, those on contract employment and with unconventional or irregular income streams (the self certification market) and those with an adverse credit history (the sub-prime, near-prime market).


  24.  Although costs have been driven down in a variety of ways and access improved, we cannot ignore the fact that home-ownership is made less affordable by stamp duty and other Government activities. Average first-timer buyer house prices now comfortably exceed the lower stamp duty threshold (charged at one per cent on purchase prices in the range £120,000-£250,000) in the three least affordable regions and are somewhat above that in East Anglia, the Midlands and Wales. Stamp duty raises the up-front cost of becoming a home-owner in the least affordable regions by around £2,000 per transaction.

  25.  The CML recently set out the range of regulatory costs that are now impacting upon lenders (CML, 2005b) and a copy is attached. Such costs ultimately feed through to customers including first-time buyers. The mortgage regulation regime recently introduced by Government (October 2004) is one such cost. Going forward, the introduction of home information packs is planned for 2007. Although it should ensure better information for buyers some of the costs are likely to be built into house prices and borne by buyers.


  26.  Low rates of house-building have profound and wide-ranging economic and social effects for the UK. The housing market is cyclical in nature, reflecting changes in the underlying economic environment. Formal estimates indicate that the responsiveness of UK housing supply to house prices is low, both in absolute terms and relative to most other countries, and has declined over time. This means that changes in the macro-economy, for example, in the job market or interest rates, potentially have a major impact on house prices.

  27.  There is some uncertainty about the precise transmission mechanism between house prices and the wider economy. The Government's Economic and Monetary Union assessment (HMT, 2003) suggested that the largely variable rate nature of UK housing finance and the relationship between house prices and consumption undermined macroeconomic stability. But more recently, the Bank of England (Attanasio et al, 2005) has queried the importance of house price effects, suggesting instead that common factors are likely to lie behind house price movements and consumption growth. The housing market, together with its influence on household spending, has nevertheless been an important consideration in the Monetary Policy Committee's decisions about interest rates.

  28.  The focus of the Barker Review is firmly on longer-term developments rather than the short-term volatility of house prices. This is sensible, given that cyclical affordability pressures are an important mechanism that ensures housing supply and demand remain in broad balance. Barker seeks to separate out and respond to structural factors, such as the UK's long-standing under-investment in house-building and demographic pressures arising from the ageing population, relationship breakdown and inward migration.

  29.  New rates of house building account for less than one per cent of the existing housing stock. By itself, this would mean that large increases in housing supply would be necessary to influence house price developments. But we believe that much of the impact of any new build is likely to be dissipated anyway. This is because it will spur existing home-owners to use more housing services—larger homes, second homes etc—and attract households to the area where new build is taking place. The overall implication is that substantial volumes of new build sustained over a number of years would be necessary to have a material impact on affordability.

  30.  As the Barker Review recognises, there are complex issues about the geographic, property-type and tenure distribution of additional new build. We will have to wait until the Government announces the details of its national affordability goal later in 2005 to judge whether it has found an effective framework within which it can deliver positive results. But this is a particularly tall order to get right.

  31.  If the Barker proposals are successful in delivering slower real house price gains over the longer-term, it is important to recognise that this may have profound market and policy implications (CML, 2003). Other things being equal, the credit risk associated with a given LTV advance will be higher than previously, and this will be reflected in lenders' underwriting criteria. In essence, lenders may become less willing to offer high LTV loans or seek to charge more for such loans, or some combination of the two. This may give rise to further differentiation across borrowers and, ironically, lessen lenders' appetite to tailor products aimed at low cost home ownership. Equity withdrawal may be restricted, with potentially profound consequences for remortgaging activity and lifetime mortgage products while lower price appreciation may reduce the appetite for buy-to-let loans.


  32.  A neglected aspect of housing supply is the difficulties lenders have been facing with restrictive covenants imposed by some local planning authorities through planning obligations (ie, s106 agreements) for affordable housing. Local planning authorities (LPAs) are adopting different approaches to affordable housing in s106 agreements and lenders find it very difficult to deal with the variety of restrictions being imposed. The current restrictions on rural exception sites under PPG3 where lenders would never be allowed to sell the property on the open market, even if an affordable need could not be identified, is overly restrictive. There is a danger that lenders will withdraw support for these schemes entirely.


  33.  The Government has stated that it sees the adoption of MMC as providing a major opportunity to produce a "step change" in housing supply. A number of high profile MMC projects have received government support and the Housing Corporation has made the availability of grant conditional on the increased use of MMC in new-build projects initiated by housing associations. Lenders are supportive of moves to create conditions in which innovation can thrive but are conscious that past generations of innovative housing construction have not always produced happy results. Much pre and post war prefabricated housing has been characterised by long-term defects and there appears to be some connection between the use of such techniques and low demand. Lenders have a long-term interest in property that has to stand as security for a mortgage of up to 35 years term. In order to help ensure that the new generation of MMC properties maintain proper standards in relation to durability, whole life costs, repairability and adaptability the CML has been working closely with the Building Research Establishment (BRE) and with the Association of British Insurers (ABI) to develop a certification standard—LPS 2020, which will provide real assurance to key stakeholders about the design, manufacture and on-site erection of MMC.

  34.  Moreover, new properties need to be built sustainably. Britain's climate is changing and houses built now need to be designed for the long term and the conditions of the future. For example, much of the Thames Gateway growth area is situated in the flood plain. The Government needs to work with the Environment Agency and DEFRA to ensure that these issues are addressed otherwise properties will be difficult to insure and therefore to mortgage.


  35.  Home-ownership is one of a number of competing tenures. There is no unique or unchanging "equilibrium" between the tenures. Changes in the conditions of demand and supply between and within the tenures will change the "equilibria" between and within the tenures. Although house prices are high, this does not necessarily mean they are fundamentally overvalued or in danger of collapse.

  36.  As Professor Nickell of the MPC has pointed out (Nickell, 2005), there are a number of reasons why the equilibrium level of house prices might have risen, as follows:

    —  The rate at which new dwellings are being built is at an historically low level whereas the population of working age and the net rate of formation of new households is relatively high;

    —  Debt-service costs in the early years of a loan are less in a low inflation and low interest rate environment; and

    —  The substantial and sustained fall in long-term real interest rates has lowered the real cost of long-term borrowing.

  37.  Why long-term real interest rates have declined to unusually low levels and what may cause that to change and when are important issues. David Miles' view is that current interest rate structures will probably not prove sustainable and the implication of this is that house prices will adjust downwards relative to incomes as real interest rates return towards more normal levels.

  38.A survey conducted for the FSA in late 2003 (FSA, 2004) showed that, at that time when base rates were 3.5% and average mortgage rates were less than 4%, a one percentage point increase in mortgage rates was expected to have little impact on households' ability to cope with their financial commitments. Broadly speaking, this is what we have observed this year. The same survey found that, if interest rates rose by 2.5%—that is mortgage rates climbed to a little below 6.5%—an additional 4% of households thought they would fall behind, and an additional 15% would struggle, with at least one form of borrowing. Assuming that the responses would be broadly consistent today, this research suggests that a rise in mortgage rates towards 6% would begin to squeeze some household budgets, but that the vast majority of households would manage.

  39.  A wide range of factors, including the distribution of unsecured credit and the type of mortgage held, would determine which households are most likely to have problems. But it seems probable that this would include some recent first-time buyers, given the highly-leveraged nature of their borrowing. A one percentage point rise in the mortgage rate to around 6% would raise the total payment of a repayment mortgage for a recent typical first-time buyer by 10%. This would be equivalent to £70 a month, or 3% of household income.

  40.  The arrears and possessions data also support the view that current levels of house prices and mortgage service are generally affordable. Although both arrears and possessions have picked up over the past year, this is from historically very low levels and has not been unexpected. It may, at least to some extent, be the natural consequence of the relatively rapid growth in self-certification and sub-prime lending in recent years, and simply reflect the maturing of these portfolios.

  41.  The sharp rise in mortgage possession court actions and orders made recently may be thought to point to a sharp rise in possessions ahead. However, such a scenario does not fit well with current and projected arrears figures. Rather, it suggests that lenders are responding more quickly to defaults partly as a consequence of the new MCOB regime.

  42.  This is not to say that the current level of house prices and affordability facing would-be home-buyers is desirable or politically acceptable. But the decisions on an acceptable level of affordability and the desired mix of tenure are ultimately matters for politicians responding to household preferences and economics rather than the mortgage lenders, who satisfy the needs of home-buyers, buy-to-let landlords and housing associations and their clients.


  43.  The Select Committee is examining an area where simple solutions are difficult. From a lender perspective, maintaining a sensible balance between demand and supply is a pre-requisite for a stable and sustainable market and where entry level house prices will be aligned with potential first time buyers.

  44.  Both lenders and government have been seeking to overcome the evident difficulties that exist in the current market. There are clear limits to what they can do. Any demand side assistance through subsidies or product pricing, if not matched by commensurate increases in supply, runs the risk of pushing up house prices. The Government is quite right to take forward the Barker agenda but it is ambitious and poses some risks.

  45.  Equally, the work government is doing around low-cost home-ownership (LCHO) is sensible and long overdue. The priority given to LCHO has been too low and too little has been done to improve the efficiency and effectiveness of LCHO schemes and providers. Both ODPM and the HC bear some responsibility here and we are still awaiting the full implementation of the Home Ownership Task Force recommendations. The CML welcomes the Select Committee's decision to conduct an Inquiry into LCHO.

  46.  We have raised the issue of stamp duty and other regulatory costs which bear down on potential buyers and on lenders costs and charges. The Government needs to respond to these concerns and not least to move forward on reforms to Stamp Duty.

  47.  It should not be forgotten that lenders have lent over £35 billion UK wide for new-build, repair and improvement to social housing. Such investment represents a successful partnerships between the public, not for profit and private sectors. Lenders have also been instrumental in promoting higher standards and expansion in the private rented sector through the availability of competitively priced buy-to-let loans now totalling over £63 billion. It is important that Government shows a real awareness of the potential contribution of the lending industry to the provision of quality affordable housing in all tenures.


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