Will the proposed relaxation of mortgage regulations boost home ownership and the economy?

In the aftermath of the Global Financial Crisis (GFC), the Financial Conduct Authority (FCA) introduced stricter mortgage regulations. These included stress testing mortgages for a hypothetical 3% increase in interest rates, and a Loan-to-Income (LTI) flow limit, which restricts the proportion of a bank’s lending that can exceed 4.5 times the applicant’s income.

These rules promoted responsible lending practices to protect against financial instability. Homebuyers would only be able to take out mortgages they could afford, creating a more resilient mortgage and housing market. And, arguably, the regulations have worked. It took until 2022 to assess them, but when interest rates increased significantly, the market held firm.

At the peak of the post-GFC fallout, 2.6% of outstanding mortgages were in arrears and 0.1% were repossessed (in Q1 2009), according to UK Finance. In comparison, the most recent data from Q3 2024 shows that just 1.5% of mortgages are in arrears and 0.02% were repossessed. In addition, more than half of UK mortgages currently in arrears were originated before the GFC. This highlights how mortgage regulation protected the housing market when the base rate spiked from 0.1% to 5.25% in under two years.

Figure 1: Possessions and arrears of outstanding mortgages

The FCA revoked mandatory stress testing in August 2022, but the LTI flow limit is still in place. However, after calls from the Government, the FCA has now published plans to simplify and reduce mortgage regulation. It is not yet clear exactly how it will change the rules, but it’s speculated that the LTI flow limit regulation could be relaxed. This would give homebuyers access to larger mortgages by allowing them to leverage up their income more.

So why would the Government want to change the mortgage regulations which have protected the UK against financial instability? It forms part of the Government’s plan to stimulate economic growth. The key aims are to boost home ownership by making it easier for first-time buyers (FTB) to access the housing market. This would then contribute to the second aim, which is to boost overall economic growth.

Regarding the first aim, evidence suggests the regulations have not actually hindered FTBs. According to the latest Bank of England (BoE) Financial Stability Report, “the LTI flow limit has not significantly reduced mortgage access for first-time buyers”. The share of mortgage lending at high LTI ratios (defined as mortgages above a 4.5 times income multiple) was 7% in Q3 2024, less than half the level of the regulatory limit of 15%.

This indicates that even if the FCA eased the LTI flow limit regulation, it may not have a significant impact on the housing market. Despite the FCA removing interest rate stress testing, individual lenders continue to enforce them to manage the risk of their mortgage portfolios. This acts to restrict the level that buyers can leverage their income anyway, as a higher LTI breaches these stress tests. It also shows that the current regulation is sufficient for lenders to offer higher LTI mortgages. The BoE report claims that saving for a large-enough deposit remains the greatest challenge for FTBs.

As for the second aim, it is certainly true that relaxing the regulations and increasing access to larger mortgages would boost housing market activity. This could then have a positive ripple effect on the broader economy; there is an established relationship between housing market activity and economic growth. The evidence shows that economic growth was higher before stricter mortgage regulation came into place. Notably, in the five years before the GFC, economic growth averaged 2.7% per year, compared with an average of 2.1% in the five years following the introduction of the regulations. Still, while growth was higher with fewer mortgage regulations, perhaps it is worth considering the knock-on effect; the GFC recession, which, arguably, was largely influenced by the buoyant mortgage and housing market, where GDP fell by nearly 5% over two years.

Moreover, economic growth is influenced by a range of factors. Therefore, it is difficult to disentangle the direct impact from regulations and housing market activity on economic growth. So, any ‘outperformance’ cannot be solely attributed to the differing regulatory environments.

It is also important to consider that boosting housing market activity could also drive excessive house prices if demand is not matched by a corresponding increase in housing supply. This inflation could make homeownership less accessible, particularly for FTBs. For example, in the decade prior to the GFC, house prices in the UK rose by an average of 12% per year. In comparison, in the ten years since the new mortgage rules came into force, UK house prices have increased by an average of 5% per year.

Our view is that any potential relaxation of the LTI flow limit would not necessarily achieve the Government’s stated aims and would need to be balanced with its potential impacts on house price inflation. The most recent demand-side stimulus to the housing market (namely the stamp duty holidays during the COVID-19 pandemic) contributed to volatile, double-digit house price inflation. A repeat of this would be counter-intuitive to meeting the main aims of a less regulated mortgage market, namely increasing homeownership and boosting economic growth.