What should a mortgage lender do when a housing bubble is about to burst? Should it a) avoid lending to dubious borrowers with an uncertain credit history or b) accelerate lending to speculative borrowers engaged in activities with a high risk of capital loss? This question shouldn't be a difficult one, yet UK banks seem to be picking option b.
As the UK housing bubble reaches the peak, banks are relaxing lending standards for buy-to-let speculators. So-called landlords can now borrow cash without any minimum rental cover or proof of income. Any fool can walk into a bank, take out a million quid loan and use it to speculate on the the UK's bloated property market.
Banks are happy to offer multi-million pound loans to people on modest salaries. Some lenders are stupid enough to offer mortgages to people with poor credit histories, some banks will even consider offering loans to people emerging from bankruptcy.
Here are some of the daft and dangerous offers out there:
Bank of Ireland - last month it lifted its ceiling on the amount of loans it will advance to any one landlord from £2.5m to £20m.
Edeus - It will lend up to £10m to buy-to-let speculators.
Mortgage Express - It has lifted its lending limit on property portfolios from £2m to £5m per customer.
The Woolwich - it will allow borrowers to build a portfolio up to £5m with loans on individual properties of up to £2.5m.
Cheltenham & Gloucester - It is now prepared to offer a buy-to-let loan based on income rather than rental coverage.
Lloyds TSB - They are also happy to forget rental values and extend a loan based on income.
The relaxation of lending criteria comes as landlords are increasingly desperate to cover their mortgage payments amid higher interest rates and rents that have lagged property prices . The "net yield" on residential property – rent as a proportion of the building’s cost – is as low as 3.5 per cent.
The only way that a new buy-to-let investment can conceivably make money is through capital gains. These buy-to-let fools would be better off putting their money on deposit at the building society that lends them the cash.
The market is now saturated with buy-to-let landlords. Last year, part-time property magnates borrowed a scarcely believable 330,300 buy-to-let loans worth £38.4bn last year, up a staggering 57 per cent on the previous year. Data from the Council of Mortgage Lenders show there were 849,000 outstanding buy-to-let mortgages worth £94.8bn at the end of 2006.
In the current bubble-addled housing market, a buy-to-let investment is just about the dumbest thing anyone can do. It is a sure-fire money loser. Sure, there are people out there who made stacks of cash on buy-to-let, but they didn't buy their investments in 2007. The UK housing market is about to crash. There are no more capital gains left out there. If you buy a house today, you will lose money tomorrow.
Given these well understood problems in the housing market, why are banks so eager to dish out the cash? After years of a rising housing market, banks have forgotten all about default risk and they can only think about returns. The banks are trying to get cash out the door so fast, that they have forgotten how to do proper credit risk assessments. However, things will change, borrowers will default, and banks will rue the day they let lending standards slip.