Tuesday, 18 September 2012

Ration mortgages to stop booms

The Chancellor is looking at giving the new City regulator, The Financial Policy Committee (FPC), the power to restrict how much you can borrow to buy a home.

The reason? To stop booms and busts.

As it says in a Treasury consultation today, the idea would be to deal with...

"over-exuberance in the upturn of the economic cycle being exacerbated by systematic under-pricing of risk, leading to asset bubbles, stretched balance sheets and other unsustainable expansionary trends. When the bubble bursts, this effect is switched around, with generalised pessimism leading the financial sector to over-price risk and be reluctant to lend, which can slow the economy’s recovery. This underlines the importance of containing the upswing."

In other words, house prices going mad and then crashing. It's too easy to get a loan, then it's too hard.

The answer is to impose "loan to value (LTV) and loan to income (LTI) restrictions," when the property shows signs of getting out of control.

These are "restrictions on mortgage financing based on the ratio of the size of the loan to the value of the property or the borrower’s income."

It would be up to the FPC to set the limits of what you can borrow. Here are the arguments:

"5.10 The Government notes that other countries’ experiences of tightening mortgage terms and conditions (including setting maximum LTV/LTI ratios) suggest this had been a somewhat effective way to limit financial instability. However, this tool has rarely been implemented in isolation from other measures, such as mortgage insurance. The Government also notes that this type of requirement can prevent borrowers who would otherwise be considered creditworthy from receiving mortgage financing."

So, in a worrying boom, you might suddenly be told that you can't have the mortgage you expected to be offered, just in case there's a bust.

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