Cover feature: Are rigid rules impeding lending?

Lenders are under fire for following mortgage regulations too rigidly and failing to innovate. Are they to blame, or are the rules themselves causing the issue?

Is the mortgage industry in a period of stability or stagnation? Your answer may depend on whether you’re a glass half-full or half-empty person.

The market has emerged from waves of regulatory change and some suggest that lenders are rightfully pausing for breath. Others say they are using this as an excuse to avoid dealing with difficult consumers and are instead taking the easy route out.

Transaction data from HM Revenue & Customs shows a significant slowdown in the second half of 2016, with just a tentative recovery at the start of 2017. We’re also yet to see what effect – if any – the UK’s exit from the EU will have in the longer term.

Government action in the past has made lenders change but that seems less likely now that all attention is focused on the snap general election and then the tricky task of Brexit. So, does that leave the market in limbo until these momentous events have passed?

Stressing the market

The financial crash of the previous decade, complete with its self-cert ‘liar loans’ and 125 per cent loan-to-value mortgages, rightly caused a change in thinking from the financial regulator. The consumer was to come first and lenders needed to ensure borrowers were able to repay.

The Mortgage Market Review arrived in 2014 and brought with it standardised stress tests. Lenders are required to test that borrowers can afford to pay for a mortgage both today and if rates were to be 3 per cent higher in future. But there are now complaints that this is too simplistic a test.

The rules mean that, in a market where the average two-year fix is available for 2.31 per cent (according to Moneyfacts), borrowers are being stressed to see if they can repay 3 per cent above the SVR – 6 or 7 per cent in some cases.

Legal & General Mortgage Club director Jeremy Duncombe thinks lenders are hamstrung by the rules but should be doing more to help customers.

“The stress test at 3 per cent above the current rate is a regulatory requirement and doesn’t allow much leeway for lenders,” he says.

“These stress tests are of paramount importance because they are vital to ensuring responsible lending, but lenders are still able to choose what they specifically class as outgoings, and their general affordability models are not prescribed, so it would be great to see more flexibility in this area.”

However, with the Bank of England’s base rate at 0.25 per cent and any significant rises looking like a distant prospect, should the stress-testing requirements be so high? Just Mortgages group operations director John Phillips says we are reaching a point where the stress-testing rules themselves need to be revised.

“Put simply, mortgage stress tests are just too tough,” he says. “They are acting as barriers to many people and are continuing to lock many out of the market altogether, including first-time buyers. Carrying out these tests on customers when we don’t know what the future holds just doesn’t make sense.”

He continues: “The regulator must look to reduce the stress-test interest rates for borrowers, particularly given the shift in economic circumstances since the rules were introduced by the Financial Policy Committee back in 2014. They are currently making it more difficult for lenders and it is also often very confusing for customers as well.”

Council of Mortgage Lenders chair Peter Hill agrees, recently outlining the trade body’s concerns about the arrangement. The stress-testing rates should be re-evaluated, he said, because market conditions have changed significantly since their introduction. The trade body is worried that the rules are locking out some borrowers from the market altogether.

Jonathan Harris, director of mortgage broker Anderson Harris, adds: “The level of 3 percentage points above the rate at any time over the first five years of the loan seems particularly harsh given that we have been in an extremely low interest rate environment for so long – a situation that shows no signs of changing any time soon.”

Not every broker agrees with these complaints, however. London Money director Martin Stewart says lenders’ hands have been tied by both the MMR and the EU Mortgage Credit Directive. He believes brokers must come to terms with the way the market now operates.

“At the end of the day, the money available to the mortgage market comes from the banks and it is entirely up to them how, when, why and where they decide to deploy that capital,” he argues.

“If some brokers are blaming the interpretation of new rules, which rule books are we blaming exactly? The MMR has been with us for years and the MCD for over 12 months, so everyone has had time to get used to the new normal.”

Innovation on hold

Even if the rules are restrictive, should lenders be doing more to innovate and draw consumers into the mortgage market?

CML data shows demand is particularly weak in the homemover and buy-to-let markets, with only first-time buyers and remortgage customers keeping the overall market going. The latter are being drawn in by historically low rates, while first-time buyers have benefited from a number of government schemes rather than from a great deal of innovation from lenders.

This lack of innovation – along with affordability – is among the biggest issues facing the market, according to Phillips.

“Lenders are continually being faced with a raft of changes that are making innovation almost impossible,” he says. “This is certainly true in terms of mortgages for the self-employed.

“The regulator must therefore make it easier for lenders to offer new and innovative products in order to cater for the changing needs of the borrower.”

“The issue of affordability is unfortunately an ongoing problem and one ‘Generation Rent’ is going to have to contend with, particularly as property prices continue to increase,” he says.

In many cases, renters are getting caught in a vicious cycle as high rents leave them unable to save for a mortgage deposit.

A recent petition, launched by renter Jamie Pogson, suggested that a strong rental payment history should be deemed sufficient proof that someone could meet mortgage repayments. It attracted more than 146,000 signatures but the Government’s response was less receptive, merely suggesting that borrowers “shop around”.

Yet Duncombe feels there is some value in lenders looking at rent payments, something which they shy away from at present.

He says: “This petition has created a lot of noise in the industry. I understand the logic from a customer’s perspective, and there must be a way that rent payments can be stressed as part of affordability testing to lend to customers while still being responsible.

“The use of five-year fixed rates could be one way of achieving this, while also protecting first-time buyers from future interest rate rises.”

Staging an intervention

Despite its short response to the rental payments petition, the Government has shown in the past it is able to recognise failures in the mortgage market and take action. Kickstarted by the launch of the two initial Help to Buy schemes in 2013, support has been given to consumers who are being failed by the market.

The figures suggest these interventions have been a success. There were 112,338 properties purchased under the Help to Buy equity loan scheme between April 2013 and 31 December 2016. The mortgage guarantee scheme enabled a further 101,960 consumers to obtain a mortgage with government support between its launch in October 2013 and its closure in December 2016.

The end of the latter scheme came after a report by the Bank of England suggesting that lenders were now offering high-LTV mortgages without the aid of the Government. But critics, such as housing charity Shelter, suggest that the various schemes served only to push up house prices.

More recently, the Government has acted to help those still saving for a deposit, with the Help to Buy Isa being followed by the Lifetime Isa. Both products offer cash incentives for those saving for a mortgage.

These initiatives have all targeted the first-time buyer market, but do lenders now need prompting to help other sectors – especially older borrowers?

“The Government’s Help to Buy scheme can take some of the credit for encouraging lenders to raise their game when it comes to high-LTV mortgages, and it has resulted in more innovation from lenders beyond the scheme,” says Harris.

“It would be good to see more innovation in the future to help other segments of the market that may have struggled to get funding, such as the self-employed and older borrowers.”

Stewart agrees: “We need to address the fact that debt is going to be carried from this generation and the next to way beyond the age of 70. We need a hybrid solution that can fill the gap between a traditional mortgage and equity release.”

Meeting a need

That’s not to say lenders are incapable of inno­vation. Brokers point to products such as the Aldermore Family Guarantee, Leeds Building Society’s Welcome Mortgage and Precise’s bridge-to-let range as examples of lenders innovating and creating products that meet a genuine need in the market.

Many smaller building societies also have had success with product ranges targeted at the needs of people in their local lending area.

Even some of the biggest lenders have got in on the act, such as Barclays with its Springboard mortgage and Nationwide with its Family Deposit product. This proves it can be done.

Lenders face more restrictions than they have in the past, and the rules should be examined to make sure they still work in the interests of consumers. Yet this is no excuse for a lack of innovation in the product space.

Whether their glass is half-empty or half-full, lenders could give us something more to cheer.

Satisfying the needs of the consumer

JEREMY DUNCOMBE, HEAD OF SALES, ABBEY FOR INTERMEDIARIES

Jeremy Duncombe, director, Legal & General Mortgage Club

Affordability and a lack of deposit are the two biggest stumbling blocks for first-time buyers.

As house prices continue to rise well above the rate of wage inflation, it’s no surprise that first-time buyers are finding themselves stuck in an endless circle of renting. The need to save for a 10-15 per cent deposit falls heavily on the shoulders of renters who are hoping to join the homeownership club, leaving them to save for longer and for more than ever before.

The Help to Buy and shared-ownership schemes have been hugely beneficial in helping first-time buyers onto the property ladder.

Help to Buy has supported 45,098 property completions, with the average age of a first-time buyer in the scheme now just 27, compared to a median age of 30, government data shows. Meanwhile, according to My Home Move, shared-ownership purchases have risen by more than 130 per cent in the past six years.

Lenders are recognising the issues that first-time buyers are facing and are modifying their services to meet the ever-changing demands of the market as well.

Furthermore, the market has adapted to the removal of the Help to Buy guarantee scheme by filling the gap and starting to lend at 95 per cent LTV. However, not all lenders have done so, and not all quickly enough. Such 95 per cent LTV products have always been a standard part of the UK housing market and it should be a priority to get us back to this stage.

It also seems that the recently launched Lifetime Isa is not going to make significant inroads in this area; instead, innovation will need to come from lenders to help Britain’s hard-pressed first-time buyers.

For a start, we need to see a parity between LTVs for new-build houses and for flats; this would really help to support younger buyers in getting onto the housing ladder.

Achieving a balance

RAY_BOULGER.gifRay Boulger, senior technical director, John Charcol

One of the provisions in the MMR was that lenders had to apply an interest rate stress test, based on a five-year view, in their affordability calculations. But it left lenders to decide what the level of that stress test should be. This discretion did not last long, however.

In June 2014 the Financial Policy Committee announced that lenders must stress on the basis of a 3 percentage point rise in Bank rate.

At the time this seemed reasonable, because it was broadly what most lenders were doing anyway. However, the problem with any centrally imposed rule is that it prevents market participants reacting in a timely manner to changes in market conditions, as the authorities are usually slower to adapt.

As always, when there is a major financial market failure, which usually also means regulatory failure, the initial regulatory response is overkill. The ideal balance, albeit difficult to achieve, is to allow market participants enough freedom to react to changes in market conditions while preventing excessive exuberance.

However, any new rules must be kept under regular review and, since the stress test was set at 3 percentage points nearly three years ago, many things have changed, particularly Brexit. The 3 percentage point figure has not.