New Central Bank rules may push house prices up higher 

Today, the Central Bank made a significant change to its mortgage lending rules – and it may have the effect of pushing house prices up even higher. 

Central Bank governor Gabriel Makhlouf announced that the authority will relax the rule that a person, or persons , seeking a mortgage can only borrow three-and-a-half times their income.

The changes will increase that ratio – so that a first time buyer can now borrow up to four times their income. The Central Bank says it is making the change because of the shortage of homes, and because of spiralling house prices.

 

The Central Bank said that the requirement for first time buyers to have a 10% deposit would not change, and that those purchasing a second home would only be able to borrow three and a half times their income.

So if you are a couple, with each of you earning an average wage, who could previously borrow 3.5 times a combined income of €90,00, or €315,000, under the new rules you can borrow an extra €45,000 or a total of €360,000.

While many of those struggling to find a home may think initially that this is good news, in reality the new rules might have the effect of pushing house prices up even higher  – and, as interest rates rise, exacerbate the risk of huge debts for overpriced homes being loaded onto young families.

House prices have been spiralling because of a constrained supply – because not enough houses are being built, and factors like the extended Covid lockdown, planning objections, increased cost of building supplies, investment funds, the energy crisis, and immigration have all made it near impossible for people on ordinary salaries to keep up.

The Central Bank says that the review it undertook of the ‘overall mortgage measures framework’ found that persistently high house prices were out of kilter with household incomes –  with what people were earning.

But the review seems to have overlooked the fundamentals of economics: if something (in this case, houses) are scarce, and if scarcity drives up the price (it has), then allowing people to borrow more money to buy the scarce resource will simply drive up the price further.

The Central Bank’s rule change is a measure that, as some observers noted today, may stoke demand even further at a time when supply is already so short. That would be a disaster – and it’s precisely why the Central Bank introduced the more restrictive lending limits in the first place.

As everyone knows, the trend in Irish banking prior to the 2008 crash was fast approaching unlimited borrowing with customers encouraged to take out loans for just about anything including a new car, an extension or a holiday, on top of existing mortgages – and many Irish consumers had multiple credit cards to facilitate maximum spend.

After it all came crashing down, the Central Bank introduced new mortgage lending restrictions which included tighter income lending multiples, and with good reason.

Going back to our example: consider that a couple was able to borrow €315,000 and is now able to borrow €360,000. That means they have more money available to bid for a home, and so do plenty of others so they will bid against each other, driving up the cost of the house.

But that’s not the only serious concern from the Central Bank decision.

What about the increasing cost of servicing loans due to the rising interest rates being imposed on Irish lenders by the European Central Bank who say the hikes are needed to curb inflation?  (An ongoing issue for Irish fiscal policies and for problems like inflation is that the ECB, not our own Central Bank, makes key decisions. Its a case of the left hand not always agreeing with what the right hand is doing).

So the average couple who have borrowed €360,000 instead of their previous limit will, at this point, pay almost €1,500 on their mortgage every month, at interest rates of 2.9% over a 30 year term according to Bank of Ireland’s online calculator.

If they had borrowed €315,000, their repayments would be €1,311 – considerably more manageable.

But another interest rate hike is fast coming down the tracks, because the ECB is meeting on October 27th – and again on December 7th – and is expected to raise interest rates at each meeting, just as the Central Bank is giving an open door to families to borrow more to buy a house.

If that happens the couple who borrowed €360,000 will see interest rates shoot up – and their mortgage repayments shoot up with them. If interest rates reached 5% (as many expect) then the monthly repayments on €360,000 would be more than €1,900 a month. That would be an enormous additional strain on an average family.

We were told earlier this month by the ESRI that house prices in Irelandare overvalued by at least 7% – and also that the rate of increase in house prices had declined for the fifth consecutive month.

The Residential Property Price Index released last week by the Central Statistics Office showed that while house prices rose 15.1% in February and March, in April the rise in prices fell back to 14.5%, decreased slightly to 14.4% in May, was 14% in June, before easing back to 13.3% in July and 12.2% in August.

Then there’s the prospect of a global recession and a cost of living crisis which is eating into what families can afford.

The Central Bank has changed the regulations to allow families to borrow four times their salaries – but perhaps families should think long and hard about what the cost of that increased borrowing might mean.

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