The second charge market has not taken off as predicted. If another roll of the dice is to make any difference in 2017, experts think the key will be adviser education
For years the second charge market has been disparaged by mainstream brokers and lenders. A lack of transparency and questionable lending practices in the past conjured an image of the Wild West in the minds of many market commentators.
Furthermore, the lax rules of the Consumer Credit Act meant consumers were not afforded the same protections as for a first charge mortgage.
For these reasons, many mainstream brokers were reluctant to recommend a second charge loan to their clients.
The introduction of the FCA’s regulatory regime on 21 March 2016, through the European Mortgage Credit Directive, was intended to be a great leveller – a kick in the proverbial backside that an often derided market needed.
Forcing second charge brokers to provide clients with a European Standardised Information Sheet has undoubtedly improved disclosure, while tougher affordability checks and more robust stress testing have given the sector more credibility.
But the FCA’s insistence that brokers make customers aware of second charge loans as an alternative to a remortgage was seen as the driving force for an inevitable boom in the sector.
That boom, however, has yet to begin. Figures from the Finance & Leasing Association show that second charge lenders advanced to borrowers last year just 4 per cent more than in 2015, for a total of £874m.
And this masks a sizeable fall during the fourth quarter, with lending down 8 per cent year-on-year at £220m.
So why has the market stagnated, when the new regime was predicted to put the second charge market on an equal footing with its first charge cousin?
It can be difficult to predict how new regulation will shape a market, particularly when that regulation is designed to change fundamentally the way the market operates.
In an early consultation paper, the FCA predicted that tighter lending rules and the introduction of mandatory stress testing would cause lending volumes to fall by 20 per cent annually. Many commentators, however, thought the sector’s newly acquired visibility would outweigh the limiting effect of more stringent criteria.
In the event, for now at least, the new regime has failed to translate into a wider take-up of second charge loans.
Precise Mortgages managing director Alan Cleary says: “Prior to the Mortgage Credit Directive, many lenders had no proper affordability assessments and therefore customers could easily get loans of 10 to 15 times income. Also there was no concept of stressing affordability for future interest rates.
“The obvious impact [of the MCD] is that those customers previously getting 15 times income cannot get the loans any more. The FLA’s figures show that the new originations of seconds have been slowing ever since.”
By April last year, just after the introduction of the new rules, more than 2,000 broker firms had applied for second charge permissions. But the numbers since then suggest brokers have been slow to take advantage of those permissions.
Such was the poor performance of the seconds market that experts warned at the end of last year that the FCA might cancel the permissions of brokers who were not using them to advise clients.
The tightening of lending rules partially explains the poor take-up of seconds. For example, one of the market’s most well-known master brokers, V Loans, shut its doors and pulled out of the sector because seconds had undergone what it called a “significant transition” since the advent of the MCD.
Paradigm Mortgage Services mortgages technical director Christine Newell says: “Most brokers are still somewhat confused about the process of recommending a second charge mortgage as an alternative solution.
“Most brokers see second charge loans as the finance of last resort, considered only when the remortgage is impossible or not viable.”
A small number of major distributors, such as Tenet and Legal & General, have launched propositions allowing their brokers to offer second charge mortgage advice without using a master broker. But most firms continue to rely heavily on master brokers to place this business.
Brightstar managing director Bradley Moore says: “Master brokers are still vital in this sector. There are more lenders than ever, meaning more criteria.
“As most brokers don’t transact seconds regularly, they don’t have the knowledge or the lender agencies to be able to offer a whole-of-market proposition.”
Newell believes a lack of knowledge among brokers is hindering growth in the sector.
She says: “There needs to be more education on when a second charge can work as a good alternative, to dispel some myths that still exist around the pricing, charges and processes.”
Rates are also a significant factor in the performance of seconds. For the past 18 months, competition in the first charge market has been fierce, leading to a sustained reduction in mortgage rates. This has undoubtedly had a limiting effect on the second charge market.
Second charges can come into their own when a borrower cannot obtain a first charge remortgage with a rate as good as that of their existing deal. In these circumstances, a second charge makes sense in order to preserve the borrower’s current rate.
But we are in an era of record-low mortgage rates. Borrowers can remortgage from as little as 1.39 per cent, making the argument for second charges less compelling. By contrast, the cheapest second charge rates on offer at the time of writing were close to 4 per cent.
John Charcol marketing director Ben Larkin says: “With record-low remortgage rates, it’s no surprise that some consumers are choosing to remortgage instead of use a second charge loan.
“We’re seeing some clients suffer an early repayment charge and take a five-year fixed rate while capital raising and I don’t envisage that reducing in the first half of this year.
“Older borrowers have seen looser criteria from first charge lenders, which again makes a remortgage a more viable option for some.”
Regulation will no doubt improve the image of the second charge market but the sector continues to be opaque in parts – particularly when it comes to fees. While some master brokers have begun to introduce flat fees, others still charge eye-watering percentages.
Just Mortgages and Spicer Haart group operations director John Phillips says: “Some master brokers reputedly still receive fees of up to 10 per cent, although some networks recently declared that their fees started at 3 per cent.
“This is still much higher than if a borrower took a mortgage or remortgage and fees like this just reinforce brokers’ opinion that clients would be better off with a transparent remortgage.
“Some master brokers have introduced flat fees in the past six months but it is essential that these fees continue to come down if second charges are really to be considered as a viable alternative to a remortgage.”
With such formidable hurdles in its way, how will the second charge market fulfil its potential? Networks and clubs have been trying to educate brokers on the merits of seconds but it is clear that more needs to be done. That said, it is still less than a year since the new regulatory regime was introduced.
It is a big task for any broker to learn all about an entirely different market from their own – especially when typically that market has been viewed with suspicion.
Larkin says: “There will always be a large proportion of clients who have a need for a more bespoke approach to capital raising, which mainstream lenders won’t look at. For example, the self-employed, consolidating large debts, clearing bridging finance, tax bills for asset-rich but cash-poor clients, to name a few. It’s all about adviser education.”
Newell thinks sourcing systems play a major part in the sector’s ability to grow.
She says: “Sourcing systems remain slow to provide solutions for comparing remortgages with alternative financing options.
“Mortgage Brain is set to come to the market with its solution and Twenty7Tec has led the way. But others lag behind and brokers see the whole process of obtaining quotes as hassle and therefore still shy away from discussing this option with their clients.”
Bank of England
But perhaps the Bank of England will have the biggest influence on the sector’s performance. Until base rate and mortgage rates increase, the argument for second charges will be difficult to make.
Some commentators do not expect rates to rise by more than a percentage point until beyond 2020. This could have serious ramifications for the growth of the second charge market.
Cleary says: “I have predicted for several years that this market would grow and so far I have got it wrong 100 per cent of the time. Until the Bank of England raises interest rates, I think this sector will remain in the £1bn-a-year range.”