The government’s new shared-equity scheme may breach the Central Bank’s lending rules which cap, for most people, the amount they can borrow at 3.5 times their salary.
The rules are in place to, among other things, prevent pumped-up house prices.
Under the scheme – which is meant to offer a route for those struggling to get a mortgage to buy their first home – the government looks likely to establish a special purpose vehicle (SPV) which will effectively go in on mortgages with first-time buyers.
The SPV would own a stake in the home and so benefit from any increases in value.
The borrowers would pay no interest on their loans from the SPV for the first five years, after which they would.
The scheme can only be used to purchase new-build homes.
Many details have yet to be decided, said a spokesperson for the Department of Housing. Like how much interest the borrower pays at the end of the five years, and whether the interest rate increases over time.
“There is no obligation to repay the loan after a certain point until the house is sold but it will make financial sense for the owner to pay down the equity stake,” said Minister for Housing Darragh O’Brien in a press release.
Enter the Central Bank
Under the Central Bank’s lending rules – also known as the mortgage measures – most borrowers cannot borrow more than 3.5 times their gross salary.
The Central Bank reviews the measures regularly with a view to “increasing the resilience of banks and borrowers to negative economic and financial shocks”, says a spokesperson.
The government is seeking investment from the retail banks in the scheme, according to Paul Hosford in the Irish Examiner.
The government is investing €75m and it wants the banks to put up €75m too to finance the SPV to the tune of €150m.
It is understood that the Central Bank will need to make changes to its rules if the scheme proceeds as it is currently designed, because of the involvement of the banks.
Sinn Féin housing spokesperson Eoin Ó Broin TD says that there is a clash between the proposed scheme and the Central Bank’s rules on mortgage lending.
Those borrowing under this scheme will be breaching that cap on borrowing, currently at 3.5 times a salary for most, so the Central Bank “will have to assess whether the mortgage lending rules will be waived or suspended to allow the banks to participate in this”, says Ó Broin.
Karl Deeter of the Irish Mortgage Brokers says that he doesn’t think the affordable housing scheme undermines the Central Bank’s lending rules.
The Central Bank has an anti-avoidance clause, a measure that is in place to stop banks from coming up with ways to get around the lending rules.
But the banks won’t be doing that in this case, the state will, he says.
“The banks didn’t come up with this the state did,” says Deeter. “And the state falls outside of the net of financial regulation from anybody including the CBI [Central Bank Ireland]”.
A Credit Bubble
One aim of the Central Bank rules is “dampening the pro-cyclicality of credit and house prices so a damaging credit-house price spiral does not emerge”, says a Central Bank spokesperson.
That means containing the flow of credit when house prices are rising, otherwise the availability of credit can pump up house prices.
“Credit begets credit, when you have asset prices rising,” says Deeter. “You can have a situation where those prices become self-reinforcing and it turns into a credit bubble.”
He doesn’t think a scheme aimed purely at first-time buyers would do that though, he says.
Ó Broin, the Sinn Féin TD, said that the single biggest factor driving up house prices is the availability of credit. “The more credit that is available the more the people who build houses factor that into their calculations.”
In the second half of the Celtic Tiger, credit was too readily available and prices surged, he says.
Banks shouldn’t do anything that pushes up prices when they are already rising like now, he says.
There is a risk that people selling mortgages will advise borrowers how to avail of more credit through the scheme, he says.
“We all have to cross our fingers and hope that banks don’t encourage their borrowers to go across the road and borrow even more,” he says.
Housing commentator Mel Reynolds says that the demand-side measures of the scheme “risk over-lending and bypassing the very important Central Bank multiples, an important safeguard against another credit-fuelled bubble”.
The Department of Housing didn’t respond in time for publication to queries as to whether the scheme will work with the Central Bank’s lending rules.
Lenders are obliged to provide sufficient information to the consumer, says Ó Broin. That means the bank must tell people from the outset the total cost of their loan repayments.
But “they cannot answer that question for the shared equity loan”, he says.
You are not borrowing a sum of money from the bank, instead the state is buying a share of your home, he says. “If your home increases in value, the amount of money you owe the state increases.”
Likewise if the interest is pegged to inflation, that cannot be predicted, he says.
Switching to another mortgage provider may also prove difficult, he says. “There is no guarantee that another lender will take on the shared-equity portion, if your financial circumstances aren’t better than when you took out the loan.”
A previous shared-equity scheme didn’t work out well for many who availed of it, he says.
For those who were able to remortgage and buy out the government’s share it was fine, but for those who couldn’t do that the interest accumulated, he says.
“The problem is that if the interest on the shared equity is increasing every year, if you don’t pay it in the first ten years, then you owe even more in the later years,” he says.
This scheme allows first-time buyers to compete for expensive, newly-built homes in Dublin but that mightn’t necessarily be in their best interests, says Reynolds.
The problem is that most apartments under construction in Dublin are high-end, build-to-rent homes, he says.
It is difficult to get finance to build housing for sale when “yield-hungry private equity firms are paying high prices”, he says.
“Why incentivise ordinary consumers to start bidding against investment firms at a time when assets are approaching all-time highs?” he says.
Still, Deeter says that the scheme offers an improvement for people who are paying high rents but want to own their own homes.
Those paying €1,800 a month in rent will be paying off a property for €1,500, he says. “From the borrowers perspective they are €300 better off per month,” he says.
The government will have a stake in their home but “they’ll have 70 percent ownership of a house”, he says. “Which is still an improvement on zero ownership.”