Looking ahead this year, one may feel a bit Donald Rumsfeld. A significant ‘known unknown’ for the lending markets is the move from an ultra-low interest rate environment to a higher-rate one.
How it will affect the bridging market is also broadly unknown, and the factors become more complex depending on how lenders are funded.
The rate rise last November had many feeling it could be followed by several others. It is more likely there will be only one rise this year, but the significance is the shift to a rate-rise environment compared to the static one we have become accustomed to over the past decade.
In the rate-sensitive mainstream market, higher rates generally mean more defaults, and there is bound to be an element of payment shock, especially among those who had never experienced a rate rise until last November.
There are also knock-on impacts for risk and affordability assessments, as well as for property prices.
Rates matter in short-term lending too but there are good reasons to see bridging as slightly less rate sensitive in terms of loan demand and performance, partly because rates usually do not rise during the loan term.
Also, lenders are funded differently: only a proportion rely on external funding, with others privately funded so not directly affected by the Bank of England rate rise.
As bridging has become more popular, competition has lowered rates by 2 per cent, 3 per cent or sometimes more in the past year, causing a dichotomy between rising mainstream rates and falling ones in short-term lending. Rates differ widely between lenders according to service, speed, flexibility and risk required.
Exit strategies will need more scrutiny in a rate-rise environment
Rates fell again in January as a mini price war took hold in bridging, mirroring what happened last year, as short-term lenders strove to kickstart January on a high.
As the previous few years have reflected, however, the bridging market is typically less price sensitive than the mainstream market. This is particularly the case among developers and other borrowers with slightly more complex requirements. While everyone wants the lowest rate, achieving completion in just a few days or obtaining lending in more complex circumstances often takes priority. As a result, modestly higher rates would be unlikely to dampen demand significantly.
Borrowers will be most affected if their exit route is a refinance onto a longer-term mortgage that now has a higher rate. All bridging lenders need to be sensitive to how the prospect of higher rates may affect clients’ exit strategies; we need to know with a high degree of confidence how the customer plans to repay.
For most clients, the exit strategy means either sale of the asset or refinancing to a long-term lender. Both potentially become harder if rates get much higher. This will be especially true for bridgers that lend to home-owners, where the requirements of MCOB affordability assessment and stress testing must inevitably bite.
However, even in unregulated or commercial bridging, exit strategies will need more scrutiny if we move to a rate-rise environment. Higher rates mean higher debt-servicing burdens and softer property price growth, which tend to dampen the market. On the other hand, rising rates are also an indicator of an improving economy so, with earnings and business investment potentially rising, there is a more positive side to the same coin.
Overall, assuming rates rise only in baby steps, I do not expect the impact on bridging to be dramatic.
Jonathan Sealey is chief executive of Hope Capital