BUYING A HOME is the biggest financial decision most people will ever make. It is usually accompanied by a substantial amount of loans, lasting several decades. Such a long-term financial commitment can seem daunting.
When we are considering buying a home and if we can afford it, we often look at various scenarios. What if our income or real estate prices go down? What if we wanted to expand our family? What if we had to move? A tug-of-war between the head and the heart can occur.
Precisely because housing decisions are so important to individuals and families, what happens in the housing and mortgage markets is also extremely important to the economy as a whole.
From rise to collapse
Housing is the most important household asset in the country, while mortgages are the largest form of household debt and the biggest credit risk on bank balance sheets. Changes in the housing and mortgage market can affect any of us. Whether we rent or own. Whether we have a mortgage or not.
History offers many lessons on how things can go wrong. In the 2000s, Ireland experienced an unsustainable real estate boom fueled by credit. Credit standards have become too flexible and mortgages too high. When that boom turned into collapse, the costs to society – the human costs – were enormous.
Almost one in five mortgages were in arrears in 2013. The banking system suffered losses that it could not absorb. The economy has entered a deep and prolonged recession, with job losses and shattered livelihoods.
The impact of the financial crisis was particularly acute for young people – many of whom had not even entered the mortgage market at this point in their lives.
About 30% of young people were unemployed in 2012; thousands have emigrated and wages have fallen sharply for graduates and new recruits. Indeed, the costs of the real estate boom and recession of the 2000s are still being felt today.
Housing construction fell sharply during the financial crisis, and in recent years the growth in demand for housing has exceeded supply. This has increased the pressures on affordability for both renters and those looking to buy a home, affecting the younger generations the most.
Drawing lessons from our past, the Central Bank introduced in 2015 a set of measures that guard against excessively flexible lending standards in the mortgage market. Although not always understood as such, measures are essential to our mission to preserve stability and protect consumers.
We know that borrowers with high debt levels relative to their income or the value of their home are more likely to face financial hardship during tough economic times.
By limiting the amount that lending banks can extend at high loan-to-income and loan-to-value ratios, the measures protect against the risk of widespread financial distress due to high levels of indebtedness.
We also know that excessively flexible lending standards in “good times” can fuel unsustainable increases in house prices, with significant costs to society when this reverses in “bad times”.
By restricting lending standards, mortgage measures protect against the risk that a credit-fueled house price boom like the one we experienced in the 2000s will recur in the future.
Similar policies were introduced in a number of countries in the decade following the financial crisis. But these are relatively new interventions, with direct and tangible effects on people, especially future owners.
With this in mind, the mortgage measures have been designed with great flexibility. The measures limit the amount of loans that can be made at higher debt levels across the economy, but do not completely prohibit this type of lending.
This flexibility allows lenders to consider the circumstances of each borrower when making lending decisions. The measures are also more flexible for first-time buyers than for those who are already owners and wish to move or buy another property. For example, about one in eight first-time buyers were extended above the loan-to-income limit last year.
Lend to Covid
Precisely because the measures can have a direct impact on people, the Central Bank reviews its effectiveness every year. This year’s review was conducted against the backdrop of the unprecedented shock from Covid-19.
Although the pandemic has had a severe impact on the economy, we entered this shock in a much less fragile position compared to ten years ago. Unlike the period before the financial crisis, we did not experience an unsustainable credit-fueled housing boom.
Households are much less indebted than at the start of the financial crisis. Lenders are in a better position to absorb the shock associated with the pandemic. The combination of these factors means that as a country we are in a better position to recover from this extraordinary shock of the pandemic than we would have been over a decade ago.
The benefits of having mortgage measures in place since 2015 are most evident at times like these, when economic conditions are tough.
Yet there is no doubt that the current state of the Irish housing market poses real challenges for people, especially young couples and families. Affordability pressures are evident in the level of rents and house prices relative to incomes, especially in urban areas.
In recent years, the supply of housing has not kept up with growing demand. Construction has been below its long-term average for about a decade. And fewer houses are built, regardless of the price point of the houses.
In 2019, 21,000 new homes were built in Ireland, about half of what was built on average each year in the second half of the 1990s. Yet house prices – adjusted for inflation – are now almost 90% higher than they were then. In a market with limited housing supply, additional debt will not help potential homeowners.
It will only spend more money to research a limited number of properties, raise prices and increase pressures on affordability. The focus should be on addressing the underlying issues regarding the volume and composition of the housing supply.
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The lessons from our own history and from other countries are clear: if lending standards become too flexible, the resulting costs to society can be very significant. Mortgage measures protect against this, protecting the economy and consumers.
At the Central Bank, we will continue to review very carefully the functioning and calibration of the measures, to ensure that they continue to protect the well-being of the Irish people.
Vasileios Madouros is Director of Financial Stability at the Central Bank of Ireland. He is responsible for the Central Bank’s work to monitor threats to financial stability and provides advice on the use of macroprudential tools, or other policy interventions, to mitigate these risks.