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Finding the golden ratio for loan to income mortgages

Will restricting the number of high loan to income (LTI) mortgages help stabilise the economy and the financial system? Richard Waller, head of financial services at TLT, comments on the recommendations made by the Financial Policy Committee (FPC).

 This article was first published on Lexus PSL Financial Services on 11 July 2014.

Consultation: Implementing the Financial Policy Committee's recommendation on loan to income ratios in mortgage lending

Mortgage lenders should not extend more than 15% of their total number of new residential mortgages at LTI ratios at or greater than 4.5, the FPC has recommended. In response, the Prudential Regulation Authority (PRA) board is consulting on proposals to implement this recommendation. The consultation is open until 31 August 2014, with the final rules expected to take effect on 1 October 2014

What is the background and purpose of the PRA's proposals?

The Bank of England's FPC is responsible for protecting and enhancing the resilience of the UK financial system. It makes recommendations to the PRA to mitigate risk to the financial system.
 
 The FPC has identified that economic stability is being threatened by increased household indebtedness. This has been brought about by a sharp rise in the number of high LTI multiples. The FPC has therefore recommended to the PRA that the number of high LTI mortgages should be restricted.

What are the proposals in this consultation?

New residential mortgages with an LTI ratio of 4.5 are to be restricted to 15%. This will apply to all lenders whose residential mortgage lending is in excess of £100m per annum. It does not apply to buy to let, lifetime, equity release, second charges, further advances or to remortgages where there is no increase in the amount lent.

How do the proposals fit with the PRA's objective?

These proposals are not about the housing market and any perceived housing bubble, which are not the responsibility of the Bank of England, PRA or FCA. They are aimed at ensuring a more stable economy and financial system thereby supporting the PRA's objective of promoting the safety and soundness of regulated banks and other lenders.

What are the next steps?

The consultation period closes on 31 August 2014, with the new rules being implemented from 1 October 2014. To determine whether a lender meets the £100m per annum threshold each lender will need to calculate the value of regulated mortgage contracts completed in the period between 1 July 2013 and 30 June 2014. If less than £100m has been completed then that lender will be out of scope, meaning that they will not be caught by the rules limiting the number of high LTI mortgages.

 Lenders will continue to make quarterly product sales data returns to the FCA. The product sales data returns will be used as an ongoing means to determine whether lenders remain in or out of scope.
 
The product sales data returns will also be used to determine whether or not lenders have complied with the 15% limit on mortgages with an LTI ratio of 4.5 and above. The limit will apply on a quarterly basis and calculated according to the number of mortgages completed rather than their value. The first calculation period that the limit will apply is Q4 of 2014. It will not be permissible to carry over any 'un-used' lending from one quarter to subsequent quarters.

How should lawyers and their clients prepare for the proposed changes?

The PRA believes that implementing this rule change will have minimal impact on the compliance and operational requirements of lenders. There will be changes necessary to systems and controls if lenders are not already monitoring their share of high LTI lending. However, no changes will be necessary to either the frequency or manner of reporting. There could also be a small reduction in mortgage lending.

 The Council of Mortgage Lenders' chairman and director of mortgages at Lloyds Banking Group, Stephen Noakes, believes that the FPC's recommendations are 'proportionate...and broadly in line' with the views of the mortgage industry. However those lenders who are in the market of very high LTI mortgages they will need to reconsider their business strategies.
 
The second charge market may be seen by some as a way of supplementing a lower LTI mortgage and thereby circumventing the effectiveness of the FPC's recommendations. In response to this risk the PRA and FCA have said they will keep the second charge market under review and take further action if necessary.

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