Income loan caps 'better' than LVR: NZIER

23:31, Jul 02 2014

Income-based caps on mortgage lending are better than loan-to-value limits for preserving financial stability, the New Zealand Institute of Economic Research says.

The Reserve Bank of New Zealand has restricted the amount of high loan-to-value-ratio (LVR) lending to 10 per cent of new mortgages, in a bid to prevent a housing bubble that could damage the wider economy and force interest rates to be hiked.

The Bank of England has taken a different approach, focusing instead on the size of mortgages compared to incomes.

Although this policy is not part of the Reserve Bank's "toolkit", it has not ruled out capping the size of mortgages in future as a way of keeping property prices under control and preventing excessive lending.

Britain's central bank has proposed restricting the share of loan-to-income (LTI) ratios above 4.5 times to less than 15 per cent of new lending.

This method has several advantages over the Reserve Bank's preferred tool of LVR limits, the NZIER said in a commentary by principal economists Kirdan Lees and Shamubeel Eaqub.

"We like this approach to financial stability because it directly targets risk: can people afford to pay back their mortgage?" they said.

"In contrast, restrictions on the loan-to-value ratio (LVR) do this only indirectly."

The LVR limits, which have caused high-LVR loans to drop from as much as 30 per cent of new mortgage lending to 5.3 per cent, had resulted in some "unintended consequences", the economists said.

The policy had done little to make the financial system safer because New Zealanders "just don't default that much", they said.

And first-home buyers, who made up only 19 per cent of the market, not the Reserve Bank's estimate of 40 per cent, had been hit hard by the lending limits, the economists said.

"But property investors, who make up the bulk of property purchases, and who can access the equity in housing portfolios built up over long periods of time, were less affected.

"These investors are less likely to be at risk of defaulting than first-home buyers since LVRs take aim at investors with low collateral, not low incomes.

"It turned out it was not highly geared first-home buyers inflating the market, rather investors who have been affected by sentiment, but not policy."

The Bank of England had set up a "reasonably targeted solution to a defined problem that they have communicated clearly", the NZIER report said.

Only 10 per cent of new mortgage lending in Britain was above 4.5 times household incomes, below the proposed limit of 15 per cent, the report said.

"It appears that much can be gained from studying closely the Bank of England's restrictions on LTI lending that are tied much more directly to financial stability risk."