MortgageMarket:The one positive is the likelihood of the ECB reducing rates next year, writes Simon Carswell, Finance Correspondent.

THE OLD joke about the banker giving a customer an umbrella on a sunny day and taking it away when it starts raining might come to mind for many people looking to invest or trade up in the property market.

A variety of internal and external factors has tightened the criteria that banks and building societies are following when providing new mortgages. Lenders are more reluctant to provide the same amounts of money they lent two years ago, because the base European Central Bank (ECB) rate, which sets the bar for the cost of lending, has doubled in two years and property prices are falling.

Banks know that customers, especially those willing to take a punt on a buy-to-let or a "fixer-upper" property they can renovate and try to sell on at profit, will not make the same money in the market as before.

Capital appreciation, bank-speak for rising house prices, was regarded as a sure thing by borrowers and lenders over the last five years. That is less certain now as the tide is going out, albeit slowly, and borrowers are unlikely to secure the mortgage deals they had become used to in recent years.

Lenders will either not offer as much in new loan applications or could revise downwards a loan approval that has not yet been drawn down. All in all, mortgage applications are being more closely scrutinised. The credit crunch has re-priced risk for many banks, so property traders/investors are having to re-price risk too.

Austin Hughes, chief executive of IIB Bank, says mortgages have fallen by close to 30 per cent between August and October of this year, compared to the same period in 2006. He says the fall-off is more to do with demand than changes in the banks' lending criteria - fewer customers are borrowing money.

"It is down to a lack of confidence among buyers and at the margin, in terms of lenders, the expectation on price appreciation has been altered," says Hughes. "There has been some tightening up of the lending criteria but in Ireland it is largely down to demand."

The credit crunch in the international markets certainly hasn't helped Irish financial institutions. While Irish banks and building societies have no direct exposure to the dreaded US subprime mortgage crisis, the international money markets in which Irish banks and building societies borrow some of the money for their day-to-day operations are still reeling from some poor lending practices in the US. The truth is that nobody yet knows the full exposure to the subprime crisis among the international investment banks. There is estimated to be between $300 billion (€204 billion) and $600 billion (€408 billion) worth of bad US subprime loans that were parcelled up and sold on in complex debt vehicles to banks and investors around the globe. This is where some Irish banks have a very limited indirect exposure.

David Drumm, chief executive of Anglo Irish Bank, said at the bank's annual results last month that the credit crunch would continue until the first half of next year when the investment banks laid their 2007 audited accounts on the table for all to see who held what share of the subprime debt. The knock-on effect of the credit crunch for Irish lenders has been the freezing of liquidity and the rising cost of inter-bank borrowing. Irish banks and building societies have strong deposit bases to fund their lending operations, but they use the inter-bank market for some of their cash flow.

Banks will pass the higher inter-bank costs on to customers in their fixed rate mortgages and business loans. This won't help property owners wanting to refinance and lock in to a fixed rate. Bridging finance has also been affected - as with mortgages, more stringent criteria are being applied.

The rising cost of inter-bank money means there will be a tightening on bank profit margins, so lenders may also not be as willing to waive an early interest payment in a lending cycle as before. With property prices falling and borrowing costs rising, property investors will see their profits margins squeezed too.

Central Bank figures released last month showed that the number of residential mortgages was still increasing in September but the growth rate was at its lowest level in five years. The growth rate in buy-to-let mortgages has also slowed dramatically since last year.

The bank said that despite high rents, the prospect of limited house price increases "may have deterred buy-to-let investors from investing in the housing market". But the bank said there was a slight recovery in the growth rate in the three months to the end of September.

The one positive light in the skies overhead is the likelihood of the ECB reducing rates as economic activity across Europe remains static or falls and the threat of inflation lessens. There is largely a consensus among economists that the ECB will reduce rates in 2008. Also, as the availability of new mortgage business falls, lenders are expected to offer more competitive deals in a bid to tempt customers to switch their mortgages from rivals. Customers are unlikely to be offered as nice an umbrella as before, but at least the banks will provide some cover in this overcast market.