Inside Housing – Commentary – Increasing homeownership will require a radical overhaul of the mortgage market
Ian Mulheirn is Executive Director of UK Policy and Chief Economist at the Tony Blair Institute for Global Change
The housing market is not working. To get more people on the ladder, we need to reshape the mortgage market. There are international examples on which one could draw, writes Ian Mulheim
The housing market is not working. While homeownership has begun to recover from its post-financial crisis lows, it still languishes at levels not seen since the 1980s. The politics of homeownership is toxic and fueling intergenerational tensions. But for too long, policymakers have been looking in the wrong places for interventions that could make a meaningful difference to homeownership.
With house prices up more than 14% in the past year, it’s increasingly difficult for first-time buyers to climb the housing ladder. But the biggest challenge for homeownership is the availability of mortgages. A dysfunctional mortgage market has kept more than a million families out of home ownership in recent years, and it’s time we started looking for solutions. Internationally, the UK mortgage market is unusual and there are many lessons we can learn from elsewhere.
Home ownership plummeted in the wake of the global financial crisis, despite a sharp drop in house prices. Excessive lending on the eve of the crisis reversed course and terrified lenders became unwilling, and to some extent unable, to take on the risk associated with high loan-to-value (LTV) loans.
As a result, the typical LTV for a first-time buyer, which was 95% in the late 1990s and around 90% in the years before the crisis, suddenly dropped to just 75% when the crisis hit. . The number of new first-time buyers halved overnight and barely recovered for the next five years, leading to an inevitable drop in the homeownership rate.
Today, lenders still demand far more equity from first-time buyers than at any point in the pre-crisis generation, with the median LTV hovering around 80-85%. Combined with record prices, this makes buying a first home more difficult than ever. Barring a very significant collapse in house prices, the increase in home ownership requires a mechanism to re-issue riskier loans to first-time buyers, rather than freezing them.
But this does not necessarily present us with a simple trade-off between high home ownership and financial stability. Mortgage markets in other countries show that there are several ways to manage financial risk more effectively than we do in the UK and therefore support home ownership without risking instability.
Two types of risk are essential. Credit risk is the first obstacle to the loan for the purchase of a first property. The risk that lenders may not be able to recover their money if prices fall and the owner defaults is pushing UK lenders to demand large deposits to protect them. Many countries, including Canada, Australia and the Netherlands, address credit risk through widespread mortgage insurance that removes much of the risk from banks’ balance sheets.
The second obstacle is interest rate risk – the fear that if interest rates rise, borrowers will find themselves unable to repay. This currently forces banks and regulators to impose rigorous affordability tests before buyers can get their hands on a loan. But long-term fixed-rate mortgages eliminate this problem, and many countries have institutions designed to boost their supply. Some other countries, such as the United States and South Korea, use mortgage insurance and long-term fixed rate products to address both interest rate and credit risk.
The UK is an international exception in that it has none of these large-scale mechanisms, leaving lenders’ balance sheets at risk. The result is a more volatile lending environment that tilts homeownership along with lenders’ risk appetite throughout the economic cycle.
Early in the credit cycle, high-ratio loans are rare and prohibitively expensive, driving down homeownership. Later, as complacency creeps in, it risks becoming too abundant and cheap – as happened before the financial crisis – increasing home ownership at the cost of excessively risky loans. Households pay the price for this stop-go credit.
Recent interventions, like the current Treasury mortgage guarantee scheme, are designed to deal with loan droughts when banks get jittery, like in the months following the pandemic. But this falls far short of structures found in other countries where homeownership is more stable, such as Canada. It is too limited and temporary to be effective, currently covering perhaps only one in 20 new loans to first-time buyers.
Meanwhile, mortgage affordability tests, although currently under consideration, look set to remain a hurdle to longer-term financing models.
Increasing and stabilizing home ownership is an ongoing policy goal for parties of all colors. But moving the needle on it requires better diagnosis of the problem than the usual focus on housing supply. It also requires radical action to reform the way our mortgage market works: a willingness to make finance work in the interests of people rather than simply insuring against systemic risks and then leaving the rest to the market.
Ian Mulheirn, Executive Director of UK Policy and Chief Economist, Tony Blair Institute for Global Change