Make sure your mortgage is affordable in the long term

The banks have promised to act responsibly to ease our way out of the housing crisis, but first-time buyers are being offered loans that could push them to the brink of disaster.

First-time buyers are still being offered unaffordable mortgages that would leave them close to the breadline, despite banks’ pledges that the irresponsible lending spree that fuelled the repossessions crisis is over.

A  mystery shopping exercise has found that first-time buyers who borrowed the maximum on offer from high street lenders and brokers would not simply be faced with a cut in their standard of living – the repayments would leave them close to the poverty line.

For borrowers in such a position, any slight change in their circumstances – an unexpected bill, reduced working hours, or having to switch to a lower paid job – would put them at risk of losing their homes.

The first-time buyer, a 28-year-old single man on £28,000 a year, was offered a £153,720 loan by Alliance and Leicester for a £180,847 property in London – a loan-to-income ratio of nearly five and half times his salary. This was with a hefty deposit of £27,127.

The monthly repayments on the four-year deal, fixed at 5.99 per cent, would be £989.48 a month out of a net income of £1,770.30 – some 56 per cent of his monthly income. It would leave the borrower just £780.82 a month to cover all living expenses and associated household costs.

According to the Joseph Rowntree Foundation’s Minimum Income Standard for Britain (MIS) report, published in July 2009, 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 2008 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,  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.

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