A couple on 100k a year with no other debt can borrow €350,000 under these limits. A couple on 100k a year with 30k debt can also technically borrow up to €350,000 according to the CB if the bank is satisfied with their own underwriting that they can afford the 30k debt repayments on top of the mortgage. But if the Central Bank only care about 'systemic risk' and banks over lending, why are they using blunt instruments that only look at mortgage debt? Individual banks will look at everyone's overall debt level and affordability so why don't we have central bank limits based on the same criteria??
Take a couple on €100. They can borrow €350k over 30 years at 2.5 at €1294 a month, or
25% of their net income of €5,160.
Take a couple on €50k. They can borrow €175k at 30 years at 2.5% at €647 a month, or
21% of their net income of €3,102.
This leaves two problems. The first is that these parameters are over-prudent. Even with a 200bp increase in rates the high-income household is pushed to mortgage payments of 34% of net income on mortgage payments, the low-income households just 28% of net income. There is a point where the pips start to squeak and it's closer to 40%. Research shows that 95th percentile for mortgage-service-to-income ratios are about 40% in many EU countries. In Ireland it's below 30%. There is headroom for people to borrow more and banks to take on more risk without catastrophic consequencies.
The second issue is that the LTI limit is calibrated on gross income (why?) but you make mortgage payments out of net income. Ireland's tax system is progressive. Your average tax rate climbs a lot when your income increases. But the LTI limits mean that low-income people are allowed much lower shares of their income on mortgage repayments. So not only are they disadvantaged by having less disposable income, but they are allowed to spend less of it on a mortgage too. Again, why?
Anyway whole LTI approach was flawed from the start. The original Central Bank
paper in 2014 said that all the international evidence was around LTV and
debt-to-income ratios, specifically looking at all borrowing of the household, not just the mortgage. Then it goes on to talk only about
loan-to-income ratios. Why? Most likely because that's what the UK was bringing in that year! The paper also completely ignored the debt service to income approach which is not standard by now across the EU except Ireland.
These measures have taken on a theological quality down the North Wall at this stage. The Central Bank was alseep at the wheel through the last boom and is determined to over-compensate. Take a look at this long
research paper which proudly details how Ireland is below or well below average on every measure of house prices or household indebtedness.
An old friend bought a house in the US recently. It was a 20% deposit, no exceptions. The Central Bank could have brought in an 80% LTV rate instead of LTI limits and literally every single mortgage issued since 2015 would be comfortably in positive equity right now even if the borrower had never made a single repayment. Is total debt an important prudential metric? Yes, in the context of a household's income and overall ability to pay. Some kind of cap on overall debt service expenditure by a household is necessary. But at the end of the day mortgages are collateralised lending and, if the collateral value is always higher than the loan, the bank is in a strong position and so is the system.
I thought these measures made sense when they were brought in in 2015. Banks had been imprudent and strong rules were needed. But Keynes said something like "when the facts change I change my mind. What do you do sir?". The economists at the Central Bank seem determined to ignore one of the greats of the profession. I think the landscape has changed a lot - not least the nearly 100bps decline in retail mortgage rates and decreases in personal taxation too - and I think the rules need to adapt as well.
