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A romance of imperfect harmony "Even though they never formally married they lasted as a couple for nearly 40 years”Britons’ obsession with housing is a dinner party cliché. When prices are falling it is a cause of panic around the table. When prices are rising, diners fret that a crash is around the corner.
Right now, young Londoners fear they may never make it on to the property ladder, while owners who bought in the north east of England in 2007 have lost money on their purchase.
There is always a cause for nail-biting among the property-owning class and those who aspire to join it. The latest political and market storm revolves around the owners who serve those who are not on the property ladder: buy-to-let landlords.
While politicians can be prone to pick on landlords as a soft target for new taxes, this week rental owners received a closer look from a different direction – the Bank of England.
It is not particularly concerned with tenants or with property prices per se. Rather, it wants to make sure banks do not get their fingers burned by overloading landlords with debt only for a house price crash to undermine the financial sector.
Deputy governor Sir Jon Cunliffe, a former Treasury mandarin, wonders if he has spotted a bubble inflating.
Buy to let (BTL) loans has grown by an average of 6pc per year since 2008, he says, accelerating to 11.5pc last year.
In 2007 around 8.5pc of all mortgages went to landlords. Now almost 15pc go into BTL purchases.
British banks have more than £215bn of BTL loans on their books, up from £146bn in 2009, according to the Council of Mortgage Lenders (CML).
That pace of growth means BTL loans are almost entirely driving net growth in the mortgage market, with owner occupier numbers holding flat. Sir Jon asked banks what their plans were – surely a giveaway that they should be on their best behaviour. Nonetheless, the lenders told him they have big plans ahead.
“At around the start of 2016, lenders were planning to grow their gross buy-to-let lending by, on average, almost 20pc per annum over the next two years, with some challenger banks and smaller building societies planning to grow their buy-to-let books at a much faster rate,” says Sir Jon.
“When some form of credit is growing fast one needs to look very carefully at whether lenders’ underwriting standards are slipping and at what is happening to the distribution of borrowers’ indebtedness.”
In the understated speak of central bankers, that is an unmistakable sign the deputy governor is worried.
Some of those standards were indeed found to be slipping. For instance, some landlords will be hit by tax changes which limit the interest relief they can claim on their income – yet not all banks were factoring that into the sums when calculating whether the borrowers will be able to afford their debts in the years to come.
Some banks are also becoming cautious – Lloyds Banking Group, for instance, this week said it has cut back its mortgage growth plans in part because so much of the growth in the market is coming from BTL. Barclays’ chairman told investors his bank has tightened lending criteria to landlords.
Last month the Prudential Regulation Authority at the Bank told lenders to do more to make sure BTL landlords will be able to pay the bills if interest rates go up. The planned rules tell lenders to test borrowers’ finances to see how they can cope with the tougher of a two percentage point rise in interest rates, or 5.5pc.
That is less strenuous than the typical rate of 7pc which owner occupiers must show they can afford – but those rules are in place in part for the protection of retail customers. They cannot sell their property as easily should interest rates rise, when landlords can sell, raise the rent or use other income to pay the mortgage.
On the other hand, Bank of England studies also indicate that landlords are more sensitive to rate rises. If interest rates rose by three percentage points, 60pc of indebted landlords could see their rent cover below 125pc of interest payments, a typical measure for financial security in the sector.
By contrast the proportion of owner-occupiers seeing their mortgage rise to above 40pc of income – also a measure of affordability – would only creep up to 4pc.
The tougher affordability checks are expected to take some of the heat out of the market. The Bank of England predicts the rule change will cut the number of cumulative new approvals for BTL loans by as much as 20pc by late 2018, reining in the market by removing those whose loans are at the margins of affordability.
That said, on other metrics BTL loans look less risky. The average loan to value ratio for a new BTL loan is 70pc, compared with 78pc for a first-time buyer according to the CML.
And Nigel Terrington, the chief executive of specialist lender Paragon, notes that arrears for buy-to-let mortgages run at approximately 0.7pc while roughly twice as many owner-occupiers are struggling with the bills.
He believes the latest worry is a case of mis-measurement by regulators who have far less data on the BTL sector than on the rest of the market.
“The level of lending this year is lower than it was 10 years ago,” he says. “Lending grew in the build up to the financial crisis, then came down by 75pc and now it has started a process of recovery. But when the number is increasing from a low base the percentage levels look quite high.”
He encouraged authorities to work harder at collecting data.
The Government has already stepped in with a stamp duty increase at the start of this month for landlords, while upcoming tax changes include limiting interest relief for BTL mortgages.
There was a tremendous spike in lending in March ahead of the stamp duty changes. CML figures show mortgage lending of £25.7bn in the month, up 59pc on the same month a year ago.
Clearly that level of lending is unlikely to be repeated immediately, and the CML believes the combination of tax changes will thoroughly take the heat out of the recent growth spurt.
“There was more business than expected in the first quarter, and now we expect to see 10,000 fewer transactions in each month in April, May and June because of the tax change,” says Sue Anderson at the CML. She does, however, agree that the tighter lending standards will “make sure the temptation for any creep in underwriting standards is very much reduced”.
Sceptics worry that regulators, having failed to spot the financial crisis coming, are simply playing a game of whack-a-mole in which sudden growth in any market is immediately deemed to be a risk, regardless of its cause.
“The track record of the regulator was appalling, seeing no risk in the run up to 2007, so now they are petrified of everything,” argues one market insider.
One could argue that such an approach of over-vigilance is better than one of negligence, and indeed the Bank of England is keen to stress that it wants to take small actions now before a risk to market stability emerges.
Other critics argue that simply looking at the headline growth figures means neglecting to consider the root causes of the increase in demand from landlords.
Andy Golding, chief executive of OneSavings Bank, argues demographic changes are key to pushing up demand for rental property.
“We think the sector has to grow by somewhere between 7pc to 10pc per year to cope with population growth, demand and the shift away from owning to renting,” he says. “But we don’t think it will grow by 20pc per year so lenders [cited by Sir Jon] are going to be left short of their plans.”
If those lenders could then be tempted to boost volumes by making riskier loans, that is where the proposed tighter rules would kick in.
The main impact of the tax changes, Golding believes, will be to squeeze amateur landlords, including pensioners looking for a better return on their savings, out of the market – again taking heat out of the sector.
Bank analysts are also on the lookout for bubbles, but right now they are relatively relaxed.
“I’ve not seen strong evidence that the quoted lenders are taking excess risks – the one I would point to as being particularly good on this is Paragon, the have a good track record… which is the best guide,” says Gary Greenwood at Shore Capital.
If problems do emerge, they might lie elsewhere. Terrington argues the Bank of England should keep an eye out for the activities of currently unregulated lenders rather than banks or building societies.
“In the BTL market you can become a shadow bank and step outside of the rules,” Terrington says.
Where are they, and how much do they lend?
“That is part of the problem.”
Shadowy indeed – just the sort of mysterious spectre to send more shivers down the spines of your dinner party guests.