Are regulators and lenders so determined that the market won’t fall back into its old sub-prime ways that they have become too cautious, to the detriment of consumers?
It is a decade since the foundations of the mortgage market crumbled, leading to the credit crunch. Ten years on, with lending criteria far more rigid, ironically there is concern that lenders and regulators have become overcautious.
Critics cite onerous stress tests of potential borrowers’ ability to repay, and the fact that some would-be remortgagers are rejected for cheaper mortgages despite having no history of missed payments.
This is all a reaction to the financial crisis, of course, the first hints of which appeared in early 2007 when numerous US lenders hit the rocks as swathes of over-indebted borrowers found themselves unable to pay back their home loans.
That contagion spread worldwide and, when Northern Rock dramatically sought urgent liquidity support in September 2007, it was clear the financial pandemic had reached UK shores, partly fuelled by a native obsession for adults to get on the housing ladder, at almost any cost.
“As always when there is regulatory failure, we had regulatory over-reaction, not just from the Financial Conduct Authority but also from the Bank of England’s Prudential Regulation Authority and Financial Policy Committee, and eventually also from the EU,” says John Charcol senior technical director Ray Boulger.
“The key question is whether the balance is right between making banks and building societies safe and giving them more flexibility to make sensible judgements.
“The FCA regulates senior individuals and so, if it believes this is robust, it should micro-manage less the decisions they make.”
Much of the current lending regime was cemented via the April 2014 Mortgage Market Review, albeit many lenders were already adhering to the new standards in anticipation of the regulation.
The winds of change have resulted in a vastly smaller sub-prime market, standard lending being limited to 95 per cent loan-to-value, a ban on self-cert, restrictions on interest-only lending, far greater scrutiny of borrowers’ outgoings, and assessment of affordability being based on rates 3 percentage points higher.
Meanwhile, from this year buy-to-let lenders must assess affordability at a minimum 5.5 per cent rate unless the mortgage is fixed for five years or longer. BTL clients must also prove that rent covers at least 145 per cent of their mortgage payments, up from 125 per cent previously.
The credit crunch fallout led to the collapse of the sub-prime and high-LTV sectors; only recently have they recovered from near-extinction, albeit to a fraction of their former size.
Figures from data analyst Moneyfacts show that in August 2007 there were 986 mortgage products available at a maximum 95 per cent LTV, but by April 2009 the figure had nose-dived to just three, not exceeding even 100 products again until 2014. There were 179 such deals available in April 2014, with 65 products in April 2016 and 269 last month.
Although nowhere near pre-credit crunch levels, the number of products has risen as a result of market competition and government intervention via the now defunct Help to Buy guarantee scheme.
On the sub-prime front, Moneyfacts data shows a colossal 7,742 such mortgages available in April 2007, collapsing to just eight in April 2009. In the intervening years, Moneyfacts changed its classification – it now cites 100 ‘adverse credit’ mortgages available in April 2016, rising to 579 last month.
“The old sub-prime system and self-cert, quite correctly, do not exist now,” says Trevor Pothecary, chief executive of specialist lender The Mortgage Lender.
“The difference doesn’t lie in product choice but in more sophisticated affordability testing and in the methodology of checking that a product is suitable. Stress testing means lenders are more prudent about when they will lend.”
Yet the new regime has resulted in too much caution, critics say.
One issue highlighted is the fate of ‘mortgage prisoners’, who, despite having missed no payments on their existing loan, cannot qualify for a cheaper rate because they fail the new strict affordability checks.
London & Country product manager Peter Gettins says: “It seems absurd that rules trap borrowers on expensive rates they service well but prevent them moving to cheaper ones.
“It was hugely disappointing that lenders generally didn’t use the transitional provisions allowed under the MMR, and it’s interesting that similar allowances under the PRA’s buy-to-let rules are much more prevalent.”
Another bugbear is the fact that affordability assessments do not take account of the LTV.
Boulger says: “The fact the MMR requires lenders to assess affordability in the same way for a 10 per cent LTV mortgage as for one at 95 per cent LTV is a nonsense, although until Brexit the FCA can’t do anything about this, even if it wanted to.
“With current regulations, one can only conclude that regulators believe lenders must be forced to apply stricter underwriting for a £20,000 mortgage on a property worth £250,000 than for an unsecured loan of £25,000, despite the fact there is no chance of the lender losing money if the first loan goes wrong but every chance if the second does.
“What’s more, the [stipulation of a] maximum 15 per cent of loans that can be above 4.5 times income is also overkill.”
Next on the list of complaints is the severity of the stress tests required to ensure a borrower can afford a more expensive mortgage. Council of Mortgage Lenders spokesman Bernard Clarke says: “Conditions have changed since the 3 per cent interest rate stress test was proposed three years ago, and approvals for house purchase are currently about 25 per cent lower than the FPC predicted.
“We believe some adjustments could deliver modestly stronger activity and a better mix of lending – without undermining financial stability.”
While there are plenty of calls to ease off the throttle on stricter criteria, some believe the market has little choice.
“It is true consumers may feel they are being unfairly punished for the greed and poor practices of banks in the late 2000s. However, I cannot see another practical solution,” says Cherry Mortgage & Finance broker Matthew Fleming-Duffy.
“I believe the market needed tougher regulation – on both an individual and a macroeconomic level. A mortgage is, for most, the largest financial commitment we will make and excessively flexible underwriting does not lend itself to sensible lending practices, which can have a hugely detrimental effect on managing a household budget.”
He adds: “Serviceable mortgage payments and household debts will lead to longer-term stability for the UK. Obtaining a mortgage should follow suitable due diligence.”
Although debate continues on whether the regulatory medicine prescribed has proved too strong, all of the brokers and lenders spoken to by Mortgage Strategy think current lending standards are firm enough to avoid another crisis.
Of course, the UK mortgage market is hugely different from that of 10 years ago. The now infamous Northern Rock ‘Together’ mortgage – which epitomised the culture of enabling consumers to own a home at virtually any price – is a thing of the past.
It allowed clients to borrow up to 125 per cent of their new home’s value and, during the credit crunch, when house prices dropped, many customers fell into negative equity.
Gettins adds: “Clearly, not repeating past mistakes is still high on the agenda for regulators and lenders.
“It is unsurprising that the focus of tighter criteria has remained on areas such as affordability. We are still at record-low interest rates so it is surely only sensible to take into account that, sooner or later, payments are going to get more expensive.”
Hindsight is a wonderful thing, of course. However, during the pre-2007 boom and even the early stages of the collapse, few people saw the credit crunch – and its severity – coming.
Mortgage Lenders Network, New Century Financial, Ownit and Sebring Capital Partners were among the first to fail. According to the Investopedia website, during February and March 2007 more than 25 sub-prime lenders filed for bankruptcy in the US. The nail in the coffin came in September 2008 when global giant Lehman Brothers filed for bankruptcy.
Speaking in early 2007 about the collapse of US lenders, erstwhile Alliance & Leicester head of intermediary mortgages Mehrdad Yousefi told Mortgage Strategy sister title Money Marketing:
“What is happening in the US will not necessarily affect the UK because it is a different market.
“US consumers have a greater thirst for credit cards than there is in the UK, and US borrowers with sub-prime loans have more debt than exists in the UK.”
Yousefi can be excused for that wayward prediction because it was the generally accepted view. It was not just the mortgage market that failed to grasp the nature of the crisis about to hit; most politicians and the media did not see it coming either.
The main cause of the UK’s credit crunch remains a matter for debate. Some blame lax lending procedures; some blame the contagion from the US; and others blame the worldwide investment banking structure that saw home loans broken up and sold to a myriad of institutions, which meant few buyers knew the origins of those loans.
But the twin backdrops for all of those suggested causes are the sub-prime and high-LTV markets.
“Irresponsible UK mortgage lending was only a small part of the story,” insists Boulger.
“While some residential lending was irresponsible, the crash can be traced back to the US Community Reinvestment Act [of 1977], which effectively forced US mortgage lenders to lend to people they had previously deemed not creditworthy.
“Bankers then managed to find a way – using sub-prime mortgage-backed securities – of palming off the liabilities that the politicians had forced them to accept to less clever bankers.”
While tighter standards exist today, risks are still apparent in the UK. The threat of rising inflation could put some households’ finances under strain; and, when interest rates eventually rise from their record lows, borrowers’ ability to pay back their mortgages may come under pressure.
For now, arrears levels are healthy. The latest CML figures show that the number of repossessed properties fell by almost 25 per cent in 2016 compared to the previous 12 months, while the number of mortgages in arrears also fell, by 7 per cent over the same period.
Clarke does not anticipate any “dramatic effects” when the base rate rises, although he expects “arrears and possessions to edge up a little in the coming period as inflation puts pressure on real incomes”.
Meanwhile, Pothecary acknowledges the “potential” ticking timebomb waiting to explode when the base rate is increased, but says stress testing will provide a defence.
Boulger thinks the market may be shielded from catastrophe if the base rate climbs slowly.
It can only be hoped that today’s lending regime proves strong enough to withstand any future storms.
As Gettins says: “The problem is that what is appropriate policy will be judged only with the benefit of hindsight.”