Only 40 per cent of households are eligible for a mortgage on an average new house, but affordability is set to improve next year as house prices fall further, according to an analysis by the Central Bank.

Last year, 50 per cent of households were deemed to earn enough to repay a typical mortgage, where repayments do not exceed 40 per cent of the borrowers' disposable incomes.

But a series of interest rate hikes reduced the amount of money that lenders could advance to first-time buyers, forcing many of them to put off the decision to buy.

The Central Bank said that only households with disposable incomes of around €44,000 or more could now afford a typical mortgage on an average property.

Frank Browne, of the Central Bank's financial stability department, said more prospective homeowners were renting instead of buying and faced increases in residential property rates of 12.5 per cent. But he said the renting trend was likely to be temporary as affordability improves.

The Central Bank forecasts that if the current trend of a slight decline in house prices continues and the interest rate cycle peaks, then around 60 per cent of households - or borrowers with disposable incomes of €23,000 or more - will eventually be able to afford a mortgage.

The Central Bank's financial stability report cautions that it could be understating the ability of people to afford a mortgage, because it only considers household income and does not take savings or other sources of wealth into account.

Although the report finds that the stability of the financial system is at greater risk than it was a year ago, it says most borrowers are well placed to cope with any shocks.

Recent borrowers are the most vulnerable, according to Central Bank governor John Hurley. He said there was no evidence so far that banks had passed on the higher cost of wholesale funding to their customers, but it couldn't rule out this possibility.

But financial stability has been much improved by a dramatic increase in the take-up of fixed rate mortgages, he said. Some 30 per cent of borrowers now have fixed-rate mortgages, up from just 5 per cent in August 2005.

Mr Hurley said there was a concern that a prolonged period of market disruption could lead to a slowdown in lending activity.