HNDA modelling mortgage impacts: guidance

This note sets out some background data that might be helpful when considering how to model the impact of changes in the mortgage market on scenario outputs from the HNDA tool:

1. background and historic data
2. possible approaches to modelling mortgage market trends in HNDA Tool

Background and historic data

There are two key inputs which can be used in the model to reflect trends in the mortgage market:

• The house-price-to-income ratio, which is used in an affordability test
• The share of households who pass the affordability test who then go on to purchase a home

The focus below will be on data relating to first-time buyers rather than home movers since the HNDA model focusses on newly-forming households and tests whether they will be able to enter the housing market.

The affordability test looks at the income of the household and calculates the maximum house price they can afford, based on the house-price-to-income parameter. The maximum house price they can afford is then compared to the point in the local housing price distribution which has been selected to determine whether the household can afford to purchase at that level of the market. The default in the tool is set to the lower quartile house price, i.e. the 25th percentile.

Figure 1 shows the trends in the average (mean) loan-to-income ratio and the average (mean) loan-to-value ratio in Scotland. These in turn are used to estimate the average price-to-income ratio (see note to Figure 1). It can be seen that during the housing-market boom of the early 2000s there was a significant increase in the price-to-income ratio. In part, this was because less restrictive lending practices enabled first-time buyers to borrow more in response to rapidly growing house prices. Despite this extra borrowing, first-time buyers also needed to save a larger deposit in order to afford the higher house prices. The distance between the solid green line and the orange dashed line represents the average deposit-to-income ratio. The widening gap between these lines from the early 2000s illustrates that on average first-time buyers had to save more of their income for a deposit.  

Figure 1. Average price-to-income, loan-to-income and loan-to-value ratios for first-time buyers (Scotland, annual data)

Source: UK Finance

Note: The mean price-to-income ratio is an estimate because it has been derived by dividing the mean loan-to-income ratio for all mortgages by the mean loan-to-value income for all mortgages. This will not be exactly the same as the mean of the price-to-income ratios for each individual mortgage.

Despite the credit crunch in 2008 and ensuing recession, the average loan-to-income ratio remained elevated. This is explained by Figure 2, which shows that the expansionary monetary policy pursued by the Bank of England to combat the deflationary impact of the credit-crunch recession led to a significant fall in mortgage interest rates. Mortgage payments associated with a given level of borrowing were therefore lower, protecting affordability.

Figure 2. Effective mortgage interest rates on new mortgages (UK, monthly data)

Source: Bank of England

The main impact of the credit crunch on the mortgage market was that banks cut back on riskier lending, as illustrated in Figure 3.

Figure 3. Higher risk lending as a share of all residential lending (UK, Quarterly data)

Source: Financial Conduct Authority

Note: Higher risk lending is classified by the FCA as a loan-to-value ratio over 90% and an income multiple greater than or equal to 3.5 for single income purchasers, or greater than or equal to 2.75 for joint income purchaser/s.

This led to a fall in the average loan-to-value ratio. Figure 4, which uses quarterly rather than annual data so as to be able to see recent trends more clearly than in

Figure 4, shows that the average loan-to-value for first-time buyers fell to 72% in Q1 2009, before gradually recovering thereafter.

Figure 4. Average loan-to-value ratio for first-time buyers (Scotland, quarterly data)

Source: UK Finance

The sharp decline in the average loan-to-value ratio from around 90% in the early 2000s meant that fewer first-time buyers were able to take out a mortgage. Figure 5 shows that the number of mortgage advances to first-time buyers in Scotland began to fall from 2006 due to the higher house prices during the housing-market boom period, and this fall accelerated following the credit crunch. The total number of mortgage advances in 2009 fell by nearly 60% from 2006 levels, even though affordability, as measured by the average loan-to-income ratio, continued to rise.

Figure 5. New mortgage advances for home purchase by first-time buyers (Scotland, monthly data and centred 12-month moving average)

Source: UK Finance