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A new estate agents shop advertising private houses in Kilcullen Village in Co Kildare. Eamonn Farrell/Photocall Ireland

The Central Bank Governor on why deposit limits are 'not targets but ceilings'

Governor Philip Lane explains why the Central Bank wants to make things easier for first-time buyers.

IT IS OFTEN assumed that the mortgage measures are of relevance only to house buyers. This is not the case.

In line with the Central Bank’s mission to safeguard stability and protect consumers, the mortgage measures are central in ensuring the stability of the financial system as a whole. And every person has a stake in that crucial objective.

In Ireland, we know only too well the painful problems caused by reckless lending and over-indebtedness.

The mortgage measures are designed to ensure that banks lend sensibly, house buyers do not over-borrow and excess credit does not build up within the Irish financial system.

Given the importance of this framework, it is wise to review the mortgage measures on a regular basis.

Today’s review is based on wide-ranging analysis by the staff of the Central Bank and has benefited from the approximately fifty external submissions we received from our public consultation process over the summer.

Overall, the review has confirmed that the mortgage measures have been successfully implemented – the banks are operating within the measures, leading to sensible lending patterns, which in turn are contributing to financial stability. The overall framework is appropriate.

The evidence shows that the probability of default for mortgages taken out under the measures is lower. Put simply, those who bought properties under the measures are better prepared to manage their mortgage payments in the event of a future downturn in the economy.

The framework requires borrowers to satisfy two requirements: A maximum loan to income (LTI) ratio and a minimum deposit relative to the size of the loan, known as the loan to value (LTV) is not too high.

Excessively high LTV ratios fail to provide sufficient insulation in the event of a downturn in house prices, pushing borrowers into negative equity.

Ireland Standalone The Central Bank says that the rules are to guard against spiralling credit rather than rising house prices. AP / Press Association Images AP / Press Association Images / Press Association Images

Time for change

Today, we are announcing some limited refinements to improve the effectiveness and sustainability of the LTV regulations, ensuring a more durable framework for the long-term.

All first-time buyers will now be required to provide a minimum deposit of 10% of the value of the property, with the LTV ceiling set at 90%.

This replaces the current system whereby a deposit of 10% was required on the first €220,000 of the price of a property and 20 per cent on the balance above €220,000.

The requirement for second and subsequent buyers to provide a minimum deposit of 20% when taking out a mortgage remains unchanged.

The buy-to-let requirements also remain unchanged, requiring investors to raise a minimum 30% deposit.

Why the change in the case of first-time buyers?

There are two main reasons for this refinement. First, the current system is complex and would require regular updating, given that the economic and financial impact of the €220,000 threshold would necessarily shift in line with the evolution of incomes, house prices and other factors.

Under the new system, the measures should require adjustments only if wider macro-financial conditions – such as material shifts in credit patterns or financial stability conditions – warrant revisions.

As an illustration, this simplification shifts the LTV ceiling for a €300,000 mortgage from 87.3% under the previous system to 90%.

Second, there was evidence at the time of the introduction of the measures showing that first-time buyers defaulted less than second-time and subsequent buyers, with the differential in default probabilities especially strong in the case of lower-valued properties.

However, the most recent data show that the differential in default probabilities is no longer weaker for higher-value homes than for lower-valued homes, eliminating an important justification for the current asymmetric treatment of lower-valued and higher-valued properties in the LTV regulations.

3/1/2014. Property Sales. Appleton Property, a new A new estate agents shop advertising private houses in Kilcullen Village in Co Kildare. Eamonn Farrell / Photocall Ireland Eamonn Farrell / Photocall Ireland / Photocall Ireland

We are also refining the degree to which lenders can grant loans in excess of the LTV limits for a limited percentage of their loan books.

Providing some capacity to lend in excess of the LTV limits allows banks to take into account the specific circumstances of individual borrowers, which sometimes may justify a higher LTV ratio.

There will now be separate allowances for first-time buyers and second and subsequent buyers.

In the long-term, this will give the Central Bank flexibility to adjust these specific limits in a calibrated way if threats to financial stability emerge.

The 20% allowance for banks to lend in excess of the LTI ceiling remains unchanged.

Finally, we have also decided to extend the current valuation period from two months to four months, to take account of the fact that some sales can take longer than the average of three months.

It is critically important to appreciate that our framework sets limits on the size of mortgages: the LTI and LTV ratios are not targets but ceilings.

In buying a home, households should take into account the risk protections offered by higher deposits, meaning they have less reliance on mortgage debt.

Equally, lenders should assess the loan-bearing capacity of each mortgage customer and restrict the size of the mortgage if indicated by the credit risk analysis.

Everybody gains from the prudent borrowing and lending patterns that are essential for a stable financial system: this is precisely what the Central Bank is seeking to protect through its mortgage measures.

Philip Lane is Governor of the Central Bank of Ireland. He is a Professor of Political Economy at Trinity College Dublin and a former assistant professor at Columbia University. He graduated with a PhD in Economics from Harvard University in 1995. 

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