Raising homeownership will require a radical rethink of the mortgage market

Today, lenders still demand far more equity from first-time buyers than at any point in the generation leading up to the crisis, with median LTV running at around 80% to 85%. Combined with record prices, this makes buying one’s first home tougher than ever. Short of a very large house price crash, boosting homeownership requires a mechanism to extend more risky lending to first-time buyers once again, rather than freezing them out.

But this need not present us with a simple trade-off between high homeownership and financial stability. Other countries’ mortgage markets show that there are several ways to manage financial risks more effectively than we do in the UK and therefore support homeownership without risking instability.

Two types of risk are key. The first barrier to first-time buyer lending is credit risk – the risk that lenders will be unable to recover their money if prices fall and the homeowner defaults, causing UK lenders to demand large deposits to protect them. Many countries, including Canada, Australia and the Netherlands, deal with credit risk through widespread mortgage insurance, taking much of the risk off banks’ balance sheets.

The second barrier is interest rate risk – the worry that if interest rates rise, borrowers may find themselves unable to afford repayments. This currently requires banks and regulators to impose strenuous affordability tests before buyers can get their hands on a loan. But long-term fixed rate mortgages eliminate this problem and many countries have institutions designed to stimulate their provision. Some other countries, such as the United States and South Korea, use mortgage insurance and long-term, fixed rate products to address both interest rate and credit risks.

The UK is an international outlier in not having either of these mechanisms at scale, leaving risk on the balance sheets of lenders. The result is a more volatile lending environment that causes homeownership to seesaw with lenders’ risk appetites throughout the economic cycle.

Early in the credit cycle, high-LTV lending is scarce and excessively costly, causing homeownership to tank. Later on, as complacency seeps in, it risks becoming too abundant and cheap – as happened before the financial crisis – raising homeownership at the cost of excessively risky lending. Households pay the price for this stop-go credit.

Recent interventions, like the Treasury’s current Mortgage Guarantee Scheme, are designed to address the lending drought when banks get nervous, such as in the months after the pandemic struck. But this falls well short of the structures found in other countries that have seen more stable homeownership, like Canada. It is too limited and temporary to be effective, currently covering perhaps just one in 20 new loans to first-time buyers.

Meanwhile, mortgage affordability tests, while currently under review, look set to remain a barrier to longer-term funding models.

Raising and stabilising homeownership is a perennial policy goal for parties of all colours. But moving the needle on it requires a better diagnosis of the problem than the usual focus on housing supply. It also requires radical action to reform the way our mortgage market works: a determination to make finance work in the interests of people, rather than simply guarding against systemic risks and then leaving the rest to the market.

Ian Mulheirn, executive director of UK policy and chief economist, Tony Blair Institute for Global Change