Mortgage Controls Dilemma for Central Bank

The Central Bank of Ireland introduced mortgage controls in 2015 and although there has been some modifications over time two restrictions still lie at the heart of the regulations, one on Loan to Value (LTV) and the second on Loan to Income(LTI). The latter limit is 3.5 (of gross income) although banks are allowed to exceed that for up 20% of their lending to First Time Buyers (FTB).

The controls are designed to increase the resilience of borrowers and lenders to economic shocks and hence reduce the probability of a repeat of the housing crash, with banks also now required to hold substantially more equity capital. The data confirms that leverage in the market is certainly a lot lower now than towards the end of the Celtic Tiger period; the median LTI for FTBs in 2020 was 3.2 against 4.5 in 2008, with 10% of loans then above an LTI of 6, compared with a figure of 3.8 last year. We cannot be sure of how lending would have developed absent the controls but the Central Bank believes that house prices and credit would be much higher, as indeed would be housing supply.

The Central Bank reviews the controls annually and will do so again this year, although this time will examine the ‘overarching framework’ as well as consulting with the public, the people the measures are designed to protect. This perhaps suggests a more fundamental change is possible and one can put forward a number of reasons why this might be the case.

The first is that the ECB and the Central Bank are concerned about the low level of profitability of European and Irish banks. All suffer pressure on net interest margin from negative rates but Irish banks are also faced with a contraction in credit to the private sector, unlike their European counterparts. Mortgage lending in Ireland is growing, but at an annual pace of 0.7% against 5.4% across the euro area.

Second, the number of active mortgage lenders here is due to contract with the proposed exit of two banks, KBC and Ulster, leaving three main providers of credit, alongside a small number of niche players.

Third , Ireland is the only euro country with an LTI limit, as it takes no account of the interest rate cycle. For example, the average new FTB mortgage last year was €241,000 which at the average interest rate of 2.8% equates to a monthly cost of just over €1000 or only 15% of the average income of borrowers (over 70% are joint applications). The same mortgage at an interest rate of 5% would cost €200 a month more and equate to 20% of that income. A current mortgage is therefore not expensive in terms of servicing and is below the average cost of renting a property, which makes little sense. That is why a debt service limit is far more common in Europe and the argument used against its introduction here in 2015 (the credit register was not fully operational) is no longer valid.

Loan to value limits are also a standard feature of mortgage controls elsewhere, and in Ireland the limit is 90% for FTB’s but here the Government’s Help To Buy scheme will allow such buyers to reclaim up to €30,000 in previously paid tax , so rendering that constraint less meaningful.

On the face of it then a move to a debt service ratio makes a lot of sense and depending on how it is set might well stimulate additional lending. This might be problematical though if house prices are rising strongly and that could indeed be the case. Prices fell last summer but have recovered since, increasing by an annual 4.4% in April and 5.3% excluding Dublin. This is actually slower than the euro norm but momentum appears to be building, with Daft,ie reporting asking prices rising by 13% in the second quarter. So it will be a fine balancing act for the Central Bank, to change the controls in a meaningful way without adding to price pressures.