London house price premium and income multiples both at historic highs, FSA warns mortgage lenders

It is striking that the gap between average London house prices and average prices in the rest of the country is now as large in percentage terms a it was in its peak in the late 1980s. On the Halifax index, the ratio of London to average house prices peaked at 1.75 at the beginning of 1988 and was again at that level in the third quarter of this year, having fallen to 1.22 in 1993.

I am not in the prediction business, and it may be that the London premium will remain at this historically high level, or that house prices elsewhere in the country will trend upwards more quickly. But clearly one cannot exclude the possibility of a fall in London house prices, which could put very high loan-to-value loans into the danger zone.

Given the level of house prices, it was particularly important for lenders to consider whether the people they lend to can afford to service and repay those loans, and for borrowers themselves to be clear-sighted about their own ability to meet this commitment. There had been a continued upward trend during 2000 in average income multiples (the number of times a borrowers income that a lender will provide as a mortgage). So lenders still needed to take more account of potential affordability problems for borrowers.

One particularly worrying trend is the continuing rise in loans at high income multiples, by which I mean above 3 for a single person or 2 for joint borrowers. The proportion of loans in this category has increased sharply, and has represented as much as a third of new lending in recent quarters, Howard Davies said.

You will all be aware that the Government have recently begun to take an interest in the whole issue of over-indebtedness and responsible lending, through the DTIs Debt Taskforce. That reinforces the need, we think, for lenders to monitor their trend in lending by income multiple. And we have been surprised to find that not all lenders do so as a matter of course.

As I pointed out earlier this year, while higher income multiples are perhaps manageable at low long-term interest rates, unsecured borrowing commitments by the same borrowers have also been rising.

There were, on the other hand, signs that lenders had responded to the FSAs warning over credit standards. Loan-to-value ratios (the ratio of loans to the current market valuation of the properties securing the loan) had moved down, with the proportion of loans exceeding 75% of house price valuation having fallen back quite markedly.

Howard Davies also talked about endowment mortgages;

One of our major preoccupations over the last year has been the problem of endowment mortgages, and how to cope with an awkward inheritance of poor selling practices in the past. There are lessons for the regulator too in this sorry story. Not least they lie in the fact that supervision methods which focus principally on individual firms did not pick up on the poor selling practices as quickly as they should have done. When we looked hard at how a cross-section of the whole industry was selling this particular product, we uncovered some uncomfortable facts.

Howard Davies explained the FSAs four-pronged approach to dealing with the problem. First, insist that consumers should get and continue to get clear and consistent information about the position of their mortgage endowment and their options for the future. Second, issue advice to consumers who consider that they have good grounds for a complaint, and guidelines to firms to ensure that they deal with such complaints properly. Third, continue to review whether some firms have chunks of past business that have led to significant consumer detriment, where the FSA will require a pro-active review by the firm and take disciplinary action. Fourth, review the current and future selling practices of firms to ensure that they are acceptable.

Finally, Howard Davies said that in building a new regime for regulating mortgages, the FSA needed to take into account that it did not hinder the innovation and competition in the market. Another key factor to take into account in building a new regime was that buyers behaved differently when taking on a mortgage than when making long-term investments.

They are often in a rush, keen to ensure that they can get the finance to secure the home they have set their sights on. Thats particularly true when prices are rising. The result is that they may not think hard enough about the deal on offer, or spend enough time shopping around. It is also the case that a wider range of consumers, including those who are less financially sophisticated, take on mortgages than take on personal pensions or life insurance policies. It follows that the information package we develop needs to help a wide range of consumers (many of whose minds are on other things) to make informed decisions.

Notes for editors

1. Howard Davies was speaking at the Council of Mortgage Lenders annual conference in London. The speech is available on the FSA website under Publications.

2. For first-time buyers the income multiple was now 2.3 times, compared to 2.2 in 1989, while nearly 20% of new loans exceeded multiples of 3 for single borrowers and 2.5 for joint borrowers.

3. The FSA regulates the financial services industry and has four objectives under the Financial Services and Markets Act 2000: maintaining market confidence; promoting public understanding of the financial system; the protection of consumers; and fighting financial crime.

4. The FSA aims to maintain efficient, orderly and clean financial markets and help retail consumers achieve a fair deal.