For many years the traditional model for assessing the amount of a mortgage loan was to use a simple mortgage multiplier. Usually the maximum loan for a mortgage would be no more than 3 times a persons salary. However increasingly banks are no longer use this. It is quite common for financial institutions to lend 5 or 6 times a person’s salary. Furthermore some banks no longer use a simple mortgage multiple but look at the issue from the perspective of affordability.
Reasons for Higher mortgage loans
- The first and most important reason is that medium and long term interest rates have been much lower and more stable. For example in the early 1990s interest rates reached a peak of 15%, since then interest rates have fallen significantly and in the past decade they have rarely been significantly above 5%. The reason for low interest rates is the changed trends of inflation. When inflation is high the Bank of England will raise interest rates to dampen demand and reduce inflation. In the post war period the UK economy used to experience periods of “Stop Go”; boom and bust economic cycles (high inflationary growth followed by recession). Therefore interest rates would often rise to reduce inflation, causing increased payments for those with mortgages. However since the Bank of England was made independent in 1997 the UK has experienced stable growth with low inflation and correspondingly interest rates have been lower. Therefore banks are willing to lend higher mortgages because mortgage payments are relatively more affordable. However if inflationary pressures were to increase significantly this policy would have to change.
- Rising price of houses compared to incomes. Since the slump of 1992 the ratio of house prices to income has risen significantly. According to the Halifax since 1996 house prices have risen by 187% way above incomes. Therefore increasingly first time buyers and others are finding it difficult to get on the property ladder. They have been resorting to various means to be able to get their first mortgage. In an increasingly competitive lending market, banks have become more flexible in meeting this demand for bigger mortgages.
- Help from parents and friends. Many of the older generation who bought houses in the 1960s are sitting on big capital gains and have now finished paying off their mortgages they are often quite willing to help their children with a deposit to buy a house or act as guarantors.
- Increased popularity of interest only and self certification mortgages. Interest only mortgages enable people to borrow larger amounts. Self certification mortgages enable people to borrow more, when proving their income is difficult.
- Financial deregulation in the 1980s increased the number of financial institutions who were able to lend money for mortgages.
- People buying together. Similar to getting help from parents some first time buyers are increasingly entering into partnership agreements with friends and family to make buying a mortgage more attainable