Loan danger

According to the Joseph Rowntree Foundation’s Minimum Income Standard for Britain (MIS) report, published in July 2019, the lowest income needed for a single working age male with no children to hit ‘a minimum socially acceptable standard of living’ (ie the absolute breadline) is £728 a month.

The loan would leave the first-time buyer with a financial cushion of just £52.82 a month separating him from the minimum income standard. It would also leave him falling short of the government’s average monthly expenditure figure of £1,227 for a one-adult, non-retired household, as set out in the 2018 Family Spending Survey, by more than £400 a month.

An unexpected bill or a drop in income could leave the borrower in serious financial difficulties and swiftly push him into arrears.

‘This level of lending could be disastrous for people on lower incomes,’ says Peter Tutton, social policy officer at Citizens Advice.

‘We have found that people with 38 per cent of their income taken up by housing costs have problems with debt. Once it gets up to 50 per cent it immediately puts your finances under pressure and if you have to live on these poverty levels of income for two or three years then something is eventually going to give.’

Stuart Freeman, director of advice services at CHAS Central London, which offers advice on housing and debt, says housing costs should not take up more than 40 per cent of income.

‘Anything over that and the potential for failure is there from day one. I come across cases where housing costs are well in excess of 40 per cent and it only needs a slight variance in peoples’ income or circumstances and they begin to get in trouble.’

‘There is absolutely no flexibility so if there is an emergency, and there are no savings or back-up, then the budget is immediately under strain,’ says Freeman.

Risky business: Mystery shopping reveals the true cost of loans to first-time buyers

Lender/Broker	Monthly payment	Loan-to-income ratio	Loan-to-value (%)	% of net income	Deal
Alliance and Leicester	£989.48	5.5	85	56%	5.99% 3 yr fixed
Barclays (Woolwich)	£988.60	5*	84.8	56%	6.99% 3 yr fixed
CMG Brokers	£901.00	5	84.8	51%	5.99% 4 yr fixed
Direct Line (RBS Group)	£944.70	4.8	90	53%	6.89% 2 yr fixed
RBS	£901.35	4.75	85	51%	6.59% 5 yr fixed
Natwest	£905.52	4.75	83	51%	6.59% 5 yr fixed
Cheltenham & Gloucester	£800.28	4.4	85	45%	6.19% 2 yr fixed
Yorkshire Bank	£840.31	4.25	95	47.5%	6.99% 3 yr fixed
Lloyds TSB	£812.43	4	–	46%	7.29% 5 yr fixed

All loans based on net monthly income of £1,770.30

The survey comes as the FSA and the Treasury consult on how to regulate banking and mortgage lending. The Turner review in March asked whether there should be product regulation including loan-to-value and loan-to-income restrictions on mortgages and the FSA is due to publish a more detailed review of the mortgage market this month.

Mortgage lenders and brokers are strongly opposed to product regulation and argue that restrictions would be an outdated response to problems that are already in the past.

The CML told the Treasury this month: ‘We are not persuaded that the FSA should assume that banning particular product features, such as high loan-to-value, or high loan-to-income or prescribing sales requirements, such as income verification rather than self certification, adequately addresses potential consumer detriment.  These approaches to product regulation risk are blunt tools to address past problems no longer prevalent in the market.’

And the Association of Mortgage Intermediaries, representing brokers, told the FSA: ‘While three to three and a half times income was the norm 20 years ago in a higher interest rate environment, in a low interest rate one – a higher level of borrowing – is clearly more affordable.’

However, ROOF’s mystery shopping investigation revealed that many high street banks are still lending at unacceptably risky levels.

Barclays offered ROOF’s first-time buyer a £140,000 loan, five times his income, for a £165,000 property in London. The monthly repayments on the three year deal, fixed at 6.99 per cent, would be £988.60 – 56 per cent of his income. After paying his mortgage the first time buyer would have been left with £781.70 a month – just £53.70 above the minimum income standard.

A £133,000 loan offered by RBS, fixed at 6.59 per cent for five years, would cost the first-time buyer £901.35 a month – 51 percent of his income – leaving him £868.95 a month.

Natwest offered a £133,000 loan, fixed for five years at 6.59 per cent, with monthly repayments of £905.52, again 51 per cent of his take home income.

Direct Line, a member of the RBS Group, was prepared to offer ROOF’s first-time buyer a £135,000 loan for a £150,000 property, with a £15,000 deposit. The loan was fixed at 6.89 per cent for two years and the monthly repayments of £944.70 would leave him with just £825.60 – £100 above the breadline.

ROOF also approached lenders seeking loans for a young first-time buyer couple with a joint income of £53,000. Barclays offered £265,000 on a £312,000 property with a £47,000 deposit. The monthly repayments of £1,871.27 would leave the couple with £1,496.83 out of their monthly £3,368.10 joint income – £323.83 above the Minimum Income Standard for a couple without children, as adjusted for 2019.

‘It’s crazy, you just need one of those incomes to go and they are in trouble. We see this quite regularly when you get a couple, married or unmarried, buying somewhere together. If there’s a problem and they want to go their separate ways, or one of them loses their income, then immediately their budget is unbalanced and the expenditure can’t be afforded,’ says Stuart Freeman of CHAS.

‘The old ratio used to be three, three and a half times joint income and I think that to go above that is totally imprudent,’ he adds.

Martin Gahbauer, chief economist at Nationwide says: ‘Most of the lending to first-time buyers is packed around the three times income multiple. When you get above the four times income multiple you’re certainly going towards the riskier end.’

Some of the worst offenders were brokers. A meeting with CMG brokers produced the offer of a £140,000 loan for ROOF’s single male first-time buyer with a £25,000 deposit. The loan was five times the borrower’s income and the monthly repayments of £901 would have left him with £869.30.

Alexander Hall brokers offered a £168,000 loan on a £28,000 salary and a £318,000 loan on a joint income of £53,000 – both six times the borrowers’ income.

Damon Gibbons, chair of the campaign group Debt on our Doorstep, says: ‘Once again, people are being put in a position where they are over-stretching themselves – bad news for the housing market and certainly bad news for borrowers.’

However, there were some lenders who exercised caution. HSBC was unwilling to lend at anything above 3.75 loan-to-income ratio on a £28,000 salary and 3.49 on a joint income of £53,000.

Northern Rock was unwilling to offer anything over three and a half times the borrower’s income, while Abbey and Nationwide were unwilling to go above four times income. Standard Life insisted on at least a 25 per cent deposit and drew the line at lending more than four times the borrower’s income.

‘If people are forced to live on poverty levels of income for two or three years, something will have to give’

The mystery shopping investigation demonstrates the importance of loan-to-income affordability checks for new borrowers, to ensure that they are not offered unsustainable loans that push them into arrears.

‘A hugely disproportionate number of the people we see in arrears have new mortgages because the payment burden is the highest,’ says Peter Tutton of Citizens’ Advice.

‘Analysis shows that this really is the danger area as, after they have paid housing costs, many people have poverty level incomes for everything else.’

With the Financial Services Authority consultation on mortgage lending imminent, campaigners are calling for more responsible lending requirements and better rules on affordability checks rather than a blanket cap on lending above a certain income multiple.

‘Rather than concentrating on formulaic income multiples, what lenders should be doing is saying, "let’s have a look at your income, expenditure and commitment, see what you can afford and think about what could happen that would undermine your ability to pay,"’ says Peter Tutton.

With huge waiting lists for social housing and the cost of renting in the private sector often prohibitive, many young people looking to set up their own households regard ownership as the most secure long-term option.

But the financial risks of borrowing up to the hilt are great. And without proper affordability checks, more and more people could find themselves tipped into unmanageable debt in an attempt to find suitable accommodation.