Watchdog warns on large loans

Homebuyers are putting themselves at risk by taking out mortgages that are large compared with their salaries, Britain's financial services watchdog has warned.

Sir Howard Davies, chairman of the Financial Services Authority, says the number of 'high income-multiple' loans - where a person borrows more than three times their income or more than 2.5 times joint incomes - has increased sharply and represents as much as a third of new lending.

The problem has been particularly acute in London, where the average property price was 75 per cent higher than the average price for the rest of the country in the third quarter of this year.

Homeowners who take out large mortgages compared with their salaries are more likely to suffer negative equity or even lose their homes if property prices fall and interest rates rise. But mortgage brokers say plenty of borrowers are willing to take the risk. Ray Boulger, of London independent mortgage brokers Charcol says: 'We had a borrower interested in borrowing seven times his income this week. We told him to go away - he clearly couldn't afford it.'

Although no lender would consider allowing a mortgage worth seven times the borrower's annual income, many are prepared to lend four times a single income or 2.75 times joint incomes if the borrower meets certain criteria. Boulger says the Woolwich will lend four times income to someone who has saved a 10 per cent deposit; the Halifax, the UK's biggest lender, will lend 4.25 times income if the borrower has a 10 per cent deposit and earns at least £100,000. Lenders are also more likely to agree large multiples for people who opt for a long-term fixed-rate loan, on the grounds that if they can afford the monthly payment now, they should be able to afford it over four or five years.

Boulger says high income-multiples are normally only extended to borrowers who can manage them - professionals whose incomes are likely to increase rapidly, or City workers who will earn large bonuses or be able to cash in share options. He believes such borrowers are not taking on undue risk given the economic environment. 'People just need to be sensible. Someone conservative about spending might manage four times their income quite easily, but another might struggle on three times their income.'

Johannes Kennard, of Bath independent mortgage brokers London & Country, believes very few buyers should borrow more than 3.5 times a single income, or 2.5 times joint incomes. 'The difference between someone borrowing three and four times their income might be minimal at current interest rates, but if rates go up, that difference will become much more exaggerated.'

He cites the example of someone earning £25,000 a year buying a £100,000 property with a 25-year repayment mortgage. Assuming interest of 5.74 per cent, a homebuyer borrowing the full £100,000 or four times their income will pay £159 more than if they borrowed £75,000.

But if interest rates rose to 10 per cent, borrowing four times income would cost £230 more.

Kennard recommends that homebuyers save as much as possible before looking for a property so they have a decent deposit. This will not only protect borrowers from falling into negative equity but could also enable them to borrow more cheaply. Repayment mortgages also reduce the risk.

He also suggests borrowers who move house should reduce their mortgage term so their loan ends at or before their expected retirement date. 'Borrowers who keep taking out 25-year mortgages could end up having to pay a mortgage out of their pension,' he warns.