Guaranteeing mortgages may not be such a great idea

Getting people on the property ladder seems to be a major goal for the UK government these days. In the UK, just like in the Us, owning your own home is considered a birthright and the most common way to save for retirement for the middle class. As A German, I find this fascination with homeownership rather baffling, especially since homes aren’t really great investments.

Yet, in his recent budget, the UK Chancellor introduced a mortgage guarantee scheme for homebuyers who can’t afford the usual 20% down payment on a house. Under the new scheme, buyers can pay down as little as 5% of the house price and the government will ensure the difference up to 20% of the value of the house.

The idea is that this will enable more people to get onto the property ladder while incentivising banks to lend to people with less capital. 5% down payments were common before the financial crisis but for obvious reasons have burnt many lenders and for the last decade these loans were simply not available anymore.

But there is a reason why these loans turned out to be toxic for banks and why they are not offered anymore. People who cannot afford a 20% down payment on a house shouldn’t buy one in the first place. A recent study of the US mortgage market has shown, how big the impact is of reducing the down payments on mortgage defaults. They found that the increase in delinquencies and defaults of homeowners on their mortgages was remarkably stable over time. It wasn’t that the housing crisis of 2006 to 2008 triggered a massively higher delinquency rate. There just were more subprime mortgages outstanding where homeowners defaulted.

On average, the study found that a 10 percentage point reduction in the down payment led to a 22.7% increase in the delinquency rate. For the 15 percentage point reduction the UK government will introduce we can thus expect something like a 34% increase in delinquency rates compared to the levels of 2020 – that is if the US experience is representative of the UK market. Compare that to an increase in the mortgage interest rate of 1 percentage point which increases delinquency rates by 1.0% and you see that reducing the requirements for down payments is likely to backfire quite spectacularly for the entity that guarantees the mortgages. In this case, the UK taxpayer.