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Cover story: Bomb scare? Time will tell

Will the eventual rises in base rate blow up in borrowers’ faces or are falling arrears and repossessions a sign that most homeowners will be able to absorb the impact?

Tick

Tick, tock, tick, tock. If you believe the doomsayers, the explosive charge of the ticking mortgage timebomb is set to detonate in the coming months because the expected rise in the Bank of England base rate could send some borrowers over the edge.

The number of arrears and repossession cases over the past few years has been far lower than predicted in the pessimists’ horror stories, with figures released last month showing arrears had almost halved since 2010. Yet that has been part-supported by the historically low 0.5 per cent base rate, which has been in place since March 2009.

There are fears, however, that all this could be about to change now that Bank of England governor Mark Carney has said the Monetary Policy Committee could consider a rate rise at the start of next year. This would put extra pressure on household finances given that more than half of existing mortgages are variable rate.

One of the safety nets in place for vulnerable borrowers is also being downscaled as the Support for Mortgage Interest benefit will be changed from a grant to a loan in 2018, as announced in the Chancellor’s July Budget.

Warning voices

Lenders say rate rises are likely to be gradual and insist their processes have improved, now being sufficient to alert and help borrowers who find themselves in the mire. Nevertheless there are loud voices warning that the market could face a problem when the inevitable rate rises happen.

“Households need time to adjust to an interest rate increase,” says Citizens Advice chief executive Gillian Guy.

“Historically low interest rates over the past six years have made it easier for people to manage their finances. A rise in rates will make things harder for those already struggling and push those who are just about managing over the edge.

“Our evidence shows one in five homeowners will fall into arrears when interest rates rise. To limit the pressure on families’ budgets, any rises in interest rate should be slow and steady and come with plenty of warning.”

She adds: “Access to money and debt advice will be essential to help prevent large numbers of people from falling into problem debt.”

Blissful ignorance

Perhaps the most vulnerable group will be homeowners who have never experienced a rate rise – meaning they have never had to cope with an increase in monthly payments.

Money Advice Trust chief executive Joanna Elson says: “There is a real risk that, after more than six years of record-low interest rates, many mortgage payers are living with a false sense of security. The reality is they may have a very short window in which to prepare for coming hikes in interest rates.

“Households urgently need to conduct a financial healthcheck to make sure they will be able to cope with higher costs.”

She adds: “We should be particularly concerned about younger homeowners, many of whom have never experienced a rate rise, as well as mortgage payers who are currently out of work or on income-related benefits.”

When the base rate eventually starts to rise, the increase is expected to be small, which will shelter vulnerable borrowers from any huge payment shocks but will nevertheless add some strain to their budgets.

In a major policy speech in July, Carney said: “Short-term interest rates have averaged around 4.5 per cent since around the Bank’s inception three centuries ago – the same average as during the pre-crisis period when inflation was at target.

“It would not seem unreasonable to me to expect that, once normalisation begins, interest rate increases would proceed slowly and rise to a level in the medium term that is perhaps about half as high as historic averages.

“In my view, the decision as to when to start such a process of adjustment will likely come into sharper relief around the turn of this year.”

The latter comment should be received with caution because Carney has previously suggested rates might rise but such hikes failed to materialise.

Similarly, a host of predictions of “imminent” rises have been made by a range of economists over the years, showing that even the best and most well-prepared experts can get it wrong. Therefore there can be no certainty that rates will indeed rise this winter.

Benign trends

The good news for now is that arrears and repossessions are at their lowest levels since 2006. Latest Council of Mortgage Lenders figures for the end of the second quarter of 2015 show there were 106,400 mortgages with more than 2.5 per cent arrears while 23,300 loans were more than 10 per cent in the red.

These numbers continue a gradual decline. At the same point in 2014, mortgages with more than 2.5 per cent arrears totalled 128,900; in 2012 there were 158,700 in this position and in 2010 there were 185,500. The figures crept up in the second half of the previous decade, from 113,000 at the end of 2006.

The CML predicts the number will fall further to 102,000 by the end of the year, rising slightly to 105,000 by the end of 2016, no doubt due to a possible rise in the base rate.

The total for mortgages that are more than 10 per cent in arrears has decreased by far less over the same period, showing that although conditions have been favourable for those on the edge of arrears, borrowers deeper in debt are still suffering badly.

At the end of Q2 2010, 26,900 mortgages were more than 10 per cent in arrears. This rose to 28,000 in 2011 and again to 29,800 in 2013 but fell to 26,500 in 2014 and further to 23,300 this year.

The CML has become more optimistic about short-term prospects for arrears and possessions since the start of 2015. It says the key reason is that interest rate expectations are lower than they were six months ago, which “provides a more favourable backdrop for households to plan their coping strategies”.

It adds that household finances have fared better than expected recently, helped by low inflation, strong earnings growth and an improving jobs market. All of this has helped benign trends in mortgage arrears and possessions to continue.

The number of repossessions in Q2 2015 was 2,500 – down from 3,000 in Q1 and 5,400 in Q2 2014. The total figure for 2014 was 21,000 – back to pre-crisis levels and down from 28,900 in 2013. The number has been falling since 2009, when repossessions peaked at 48,900.

CML spokesman Gareth Hill says: “It is a real mix of reasons why possessions have stayed low, as are the means by which lenders assist those having payment issues. But indeed interest rates are a factor, although not the only one.

“Lenders have made special efforts to engage with borrowers on the issue and have made possession a last resort.

Early engagement, and a concerted effort to promote it, has been key to allowing for as many payment options as possible to be discussed, and it appears borrowers who have upcoming payment issues have been likely to engage with lenders more.

“Studies have also suggested that consumers in general now prioritise mortgage payments above other spending and adjust their spending month to month accordingly.”

Payment confidence

Meanwhile, the latest Lloyds Bank Lending Report reveals an upbeat public when questioned on the subject of their finances. Confidence in paying off unsecured debt remains high, with 83 per cent of those surveyed feeling confident or very confident that they would meet their future repayments.

Fewer people have missed payments compared to the beginning of the year, with 11 per cent saying they had missed at least one payment in the past 12 months versus 13 per cent in Q1 2015.

Nevertheless, the Financial Conduct Authority has called on lenders to ensure they do everything possible to help struggling borrowers. In its February 2014 report on mortgage lenders’ arrears management and forbearance, the FCA found good practice among many banks and building societies but called for lender action to identify customers who would be susceptible to arrears if interest rates were to rise, and to ensure they had appropriate strategies to treat them fairly. It says that message still stands today.

In particular, the regulator wants firms to ensure their systems and people support and empower front-line staff to make appropriate arrears-related decisions. It also wants them to provide greater flexibility to support fair treatment of individual customers, based on their personal and financial circumstances.

Debt denial

Of those whose home has been repossessed, the Financial Ombudsman Service maintains that some cases could have been avoided if homeowners had reacted more quickly to their circumstances, supporting the notion that consumers must take responsibility for managing their finances, just as lenders have to do.

The FOS reported last year that an increasing number of borrowers with concern about losing their home were nevertheless in ‘debt denial’ and risked leaving it too late to seek help. Of more than 13,000 customers who contacted it for help with a mortgage or secured loan problem, one-third had slipped into arrears before doing so.

Chief ombudsman Tony Boorman said at the time: “Many of the cases where people faced losing their home could potentially have been avoided. So if money is tight, people should never be afraid to ask for help or guidance. Speak up sooner rather than later – there’s a lot that can be done to help before things get out of hand.”

Safety net removed

However, one helping hand for consumers has been partly eroded as a result of the Summer Budget. The Support for Mortgage Interest grant will become a loan from 2018 and the waiting period for it will be extended, from 16 to 39 weeks, from 2016.

Currently about 200,000 borrowers use this safety blanket and charity Shelter says the average SMI claimant receives around £1,800 a year, which is a substantial sum for many.

The CML called the SMI announcements the most significant mortgage news in the Summer Budget although it has yet to fully analyse their implications.

Shelter policy officer John Bibby says: “Shelter has previously warned that switching SMI to a loan may discourage some households from seeking help and instead encourage them to sell their homes. We, like lenders, are waiting for more details to see how the changes may affect the quality of the support that is provided for those who need it.

“The extension means that from 2016 the few homeowners who are eligible will have to wait the best part of a year before they can get the support that might keep them in their home. This is not only something that we should regret as a missed opportunity; it may have serious practical implications.”

Intermediary Mortgage Lenders Association executive director Peter Williams says: “The fact that the Government will provide SMI payments only as loans from 2018 shows it wants homeowners to stand on their own two feet financially.

“But with rates certain to rise by then, the move is likely to increase the pressure on those households that are already the most vulnerable. Presumably the Government will provide the new SMI loans rather than expecting lenders to do so. But it remains to be seen what further steps will be taken in the meantime to create a fairer housing market that puts less pressure on individuals’ household finances.”

The CML is confident its members have acted responsibly over the past few years in ensuring borrowers have taken out mortgages they could genuinely afford. However, a lot of customers with a mortgage taken on many years ago may still be on their lender’s standard variable rate and have been sitting pretty for years. Those who took out a Cheltenham & Gloucester or Nationwide mortgage in the previous decade may be paying an SVR of just 2.5 per cent.

Regulatory effect

More recently, lending rules have been tightened significantly thanks to last year’s Mortgage Market Review, which stated that lenders must stress-test mortgages against a base rate 3 per cent higher than the current level. Although these rules became official in April 2014, many lenders had already adopted them before the deadline.

Perhaps in response, about 90 per cent of new mortgages at present are fixed-rate deals because “consumers are already factoring in the possibility of a rate rise”, according to the CML. However, while many borrowers have prepared themselves in this way, those whose introductory offer has long since expired and who have yet to remortgage will not be protected against rate rises. And future borrowers on a fixed deal will probably have to pay more to remortgage when rates rise.

Another CML statistic puts 47 per cent of all outstanding regulated mortgages on fixed rates, which means of course that more than half are not. But the trade body notes that, because any rises are likely to be gradual, this will soften the blow for consumers.

For a £120,000 mortgage, an increase to the average rate of 25 basis points would lead to a rise of £15 in average monthly payments, which many households should be able to afford.

Hill says: “Debt service costs for first-time buyers amount to 18.2 per cent of income currently. A 25bps rise would increase this to 19.1 per cent and a 100bps rise would take it to 20.7 per cent. These are much lower than the proportions seen around the time of the financial crisis, of 24.8 per cent of income.”

Lloyds Banking Group says it operates a number of schemes to assist borrowers who are experiencing financial stress, adding that “repossession is always a last resort’.

It also ensures “that mortgages taken out by customers suit their needs and circumstances and that they are able to repay them and are not likely to face financial hardship”.

A spokeswoman adds: “We test all customers to a 7 per cent interest rate before approving their mortgage application to ensure borrowers will be able to afford their repayments when interest rates rise.”

Broker role

Brokers, naturally, can play a role in easing the burden for struggling households, whether by guiding them with budgeting support or transferring them to cheaper mortgages.

While lender rates have crept up over the past few weeks, they are still among the lowest on record. The days of fixing for five years at less than 2 per cent are over but, at about 2.15 per cent at 60 per cent loan-to-value, current deals are very cheap compared to historical trends. Awareness of this should produce a sense of urgency in borrowers in case lender rates continue to edge upwards.

London and Country associate director of communications David Hollingworth says: “Borrowers who are anxious about and vulnerable to the threat of a rate rise should be reviewing their situation now in an effort to protect themselves against rising costs.

“Brokers are ideally placed to help borrowers understand the options. With a wide range of extremely competitive fixed rates on offer, it may be that they can lock in to a low rate to give real security.

“Criteria will play a big part in that so advice will be crucial. There is a danger that borrowers will feel they have nowhere to go simply because one lender has rejected them, when a tailored recommendation would produce a good fit.”

Given that nobody seems any clearer on when the Bank rate will start to rise, future trends in arrears and repossessions are hard to predict. It seems we will have to wait until at least the first increase in base rate before we will know if the market has been sitting on a ticking time-bomb or on a dud all along.

Sellar

Arrears and repossession – the Santander view, by Graham Sellar, head of business development

How has Santander and the wider lending community helped those in trouble over the years and how do you see that evolving?

Our aim is to help and support customers through periods of difficulty by offering affordable measures to get their mortgages back on sustainable terms as quickly as possible. We’ll consider a range of solutions including term extensions and temporary reduced repayment plans. Where customers are experiencing difficulty, we operate a direct referral to non-fee charging debt assistance firms and charities. During this time we’ll give customers the space and time they need to agree the most appropriate solution for them.

Across all our channels we work closely with our teams internally and through intermediaries to make sure that when someone is applying for a mortgage they can afford it. We review affordability at the point of sale and have a series of measures to assess borrowers’ finances and their projected financial situation throughout the lifetime of the mortgage. This is in line with the potential 3 per cent base rate increase over five years that we work with from BoE direction.

An important evolution is how we support vulnerable customers. Like Santander, most lenders operate a case management approach when a customer is identified as vulnerable. Having the systems, processes and bespoke solutions in place to ensure that the most vulnerable customers receive the right outcome from lenders is essential.

Arrears and repossession figures are nothing like the horror show some have predicted. Is the reason simply low interest rates or are other factors at play?

Low interest rates are a factor and availability of new mortgage deals is another aspect but lenders’ approach to forbearance has also contributed. Repossession of a property is the absolute last resort but it is key to note that, in some cases, exiting the property is the right thing for the customer.

We also assist when customers in financial difficulty are trying to sell their property. We work with property management and conveyancing firms and use those relationships to help customers.

Are both the market and consumers ready for an interest rate rise? Will it inevitably push up arrears and repossessions, and to what extent?

We feel that the majority of lenders will take a proactive approach. We have the information that helps us identify customers we think are most susceptible to an increase in monthly payments and we will contact them and offer assistance.  Also, consumer awareness is greater now as a result of the prolonged period we have had in a low interest rate environment and the press coverage of a future rate increase. This can be only a good thing as certainly some customers will take steps to prepare.

It has been eight years since the last rate increase so we understand that customers may not have had increases before. The majority of customers are on fixed rates so will not be affected until those rates mature. We would be surprised if there was a noticeable increase in arrears and repossessions as a result of the first increase. Of course there is a tipping point as rates rise further but for the first increase we expect most customers (with the assistance of lenders where needed) to be able to make the necessary adjustments.

What do you think the impact will be of turning Support for Mortgage Interest into a loan?

We believe this will have wide-ranging implications for the industry. The repayment terms of the Support for Mortgage Interest  loan are key – that is, too short –  and it could lead to long-term affordability stress for the people who are in most need of assistance.  For lenders it will inevitably mean changes to systems and processes to take into account the repayment of an additional loan at the end of the support period.  Customers may need further assistance from lenders while the loan is being repaid. On a positive note, we have a number of years to plan as an industry and prepare customers for any potential payment changes.

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