An approach adopted for the specialist buy-to-let sector is now making its way into the residential mortgage market
Have you heard of the Formula One ‘trickle-down effect’? Essentially, it describes the process of technology developed by experts in F1 motor racing eventually finding its way into the road cars we use every day: fuel-efficient engines, carbon-fibre construction, flappy paddle transmissions, active suspension, traction control, anti-lock brakes…the list goes on.
In fairness, the effect is not restricted to F1; everything from sports equipment to cookery utensils has benefited. So does the trickle-down effect work in the mortgage market as well, to the benefit of borrowers?
I think it does. It is currently evident in the way in which affordability tests are being applied by lenders. An approach adopted for the specialist buy-to-let market is now making its way into the residential mortgage market.
Brokers are well aware that, when it comes to buy-to-let mortgages, lenders must apply the new FCA stress test that says a notional rate of 5.5 per cent must be used for assessing affordability, to ensure that borrowers could cope with future rises in interest rates. However, if a deal is based on a five-year fixed rate or longer, this notional rate does not apply and the stress test can be carried out using the pay rate. The benefit for borrowers is that they can borrow more, while, for property investors, being able to maximise the degree to which they can leverage their assets often makes good sense.
Until recently, few lenders carried this approach across into the residential market. But now the trickle-down effect is evident.
For example, most mainstream lenders do not differentiate by product when it comes to affordability. However, Aldermore, Dudley Building Society, Kent Reliance, Pepper Homeloans, Precise Mortgages, The Mortgage Lender and Vida Homeloans have all taken a different approach and offer residential five-year fixes where the stress test is based on pay rate, thus enabling the applicant to borrow more.
Take this example: a single applicant with no dependent children earns £50,000 a year and is purchasing a house using Dudley’s five-year fix available exclusively via 3mc. A deal based on a five-year 2.89 per cent fix gives a loan of £295,000 when stress tested at pay rate. However, Dudley’s 2.99 per cent two-year fix (a very similar rate) enables a loan of only £214,500 when stress tested using a notional rate. That is a difference of £80,500.
I am not suggesting that brokers should encourage every client to borrow as much as they can by applying for this type of five-year fix. But in appropriate circumstances it gives greater flexibility than was previously available. It is another option and a very welcome trickle-down benefit.
Doubtless other product and service features will trickle into the mainstream market in due course. Lenders are sometimes accused of not being innovative and being unwilling to develop products more closely aligned with borrowers’ needs. However, if you look hard enough there is evidence of more enlightened thinking taking place.
Of course, F1 motor racing and the UK mortgage market are not very comparable, but this may be one area where there is some common ground.
Doug Hall is director of 3mc