Increase in loan to earnings ratios a risk to property market if it continues

The rise in loan to earnings ratios to levels not seen since the 2008 property collapse may produce a risk of a future property crash if it continues, according to a study by property management firm DJ Alexander.

The family run property management company said the news that lenders had once again reached six times loan to earnings ratios in lending was a concern for future market stability.

The highest ratio currently on offer is six times income offered by the Darlington Building Society which, tellingly, has not offered this scale of loan since 2007. Other lenders are offering 5.5 times earnings while the average ranges between 4 and 4.75 so there has been a gradual increase in the amounts being offered since 2008 when such offers disappeared almost overnight from the marketplace.

In the UK the average house price peaked in September 2007 at £190,032 and fell sharply in subsequent months. It did not reach that figure again for nearly seven years until August 2014 (please see table below for average price breakdown of countries). It took nearly seven years for average house prices to reach their earlier peak in the UK and England and in Scotland it took nine years while in Wales it took just under ten years.

David Alexander, managing director of DJ Alexander Ltd, said: “A generation of homeowners has grown up with extremely benign interest rates and are unaware of just how they can rise in a relatively short period. They want to borrow as much as they can and, it would appear, lenders are complying.”

“Optimists will argue that the ratio doesn’t matter if the individual can afford it and of course that is true. However, it makes a lot of assumptions including no increase in interest rates, no change in personal circumstances, the impact of Brexit on the market and employment, flat inflation so no rising costs to challenge your ability to maintain your budget, and that house prices will rise inexorably upwards. With so many variables what could go wrong?”

Mr Alexander continued: “But there is good news. Although these very high ratios are available the average scale of lending is much lower. In the latest month for which there are figures first time buyers borrowed an average of £171,830 which was 4.1 times the average household earnings. For existing owners who moved home they borrowed an average of £223,684 which was 3.9 times average household earnings.”

“Therefore, although some ratios on offer are very high, they are at the extreme edges of the marketplace. Letting such ratios get higher and given to a larger number of borrowers is where the concern lies. While a few borrowers may be in a position to service such debts even if interest rates rise it should not become the norm if we are to avoid a similar fallout as we experienced in the last property collapse.”

David concluded: “It is important that lending should remain controlled and reasonable. Interest rates have been so low for so long that you could be forgiven for thinking that they will never reach five or six per cent again. Given that we are in the midst of a major political upheaval in the form of Brexit that situation may change rapidly to cope with an economy that is in flux. Therefore, lending should be as free and open as possible but still build in appropriate leeway to individuals who may find their affordable mortgage becomes unaffordable in the future. The market can cope with a few people in that situation but when it starts to be thousands who can’t pay their mortgage then we may be in trouble.”