Cover story: Long-term commitment

Increasing numbers of buyers are seeking mortgage terms of 30 years-plus to make their monthly payments more affordable – but how sensible is this?
Stretch

It is not how long they are but what you do with them that counts. That is the cry from the mortgage industry on the subject of, well, mortgages.

The message comes as new research points to growing demand for deals of 30 years or more as clients seek new ways to reduce monthly payment burdens.

Regulators have voiced concerns over the increasing length of mortgage terms, primarily because it risks borrowers paying off their home loan into retirement.

Prudential Regulation Authority chief executive Andrew Bailey warned last year: “We have to watch this very carefully because, if mortgages extend beyond the point at which income falls off, we have a long-term problem.”

Yet the retort from a lot of brokers and lenders is that lengthier mortgages work for many people, especially younger clients, so if they are used correctly they are a perfectly sensible choice.

In fact, some believe term length is not discussed enough when borrowers choose a mortgage, which risks clients failing to take on a longer term that may be more suitable for them.

John Charcol senior technical manager Ray Boulger has even called on the Financial Conduct Authority to ban forms on calculators that default to 25 years because these encourage a “lazy” decision to stick with that term (see Comment box below).

Research from the Mortgage Advice Bureau in August shows that increasing numbers of homebuyers are searching for mortgage terms of more than 30 years to make their monthly payments more affordable. Its Mortgage Search Tracker data shows 21 per cent of homebuyers seeking a mortgage in the second quarter of 2015 looked to stretch their repayments over a minimum of 30 years – a sharp rise from the 8 per cent recorded a year earlier.

However, in contrast to homebuyers, remortgagers are searching for shorter terms. More than one in 10 sought a 15- to 24-year mortgage term in the same period, the research shows.

MAB head of lending Brian Murphy says: “Homebuyers are tearing up the rulebook by searching for longer-term mortgages to secure cheaper monthly repayments. However, in the long run this can add up to an extra outlay of thousands with the added interest that comes with borrowing for longer.”

It is not just analysis of data that paints this picture; brokers on the ground report a growing appetite for longer-term deals.

Cherry Mortgage & Finance broker Matthew Fleming-Duffy says: “We have certainly seen an increase in demand for longer-term mortgages, on the understanding that a 25-year term has been historically identified as a standard term.”

Latest figures from the FCA highlight this trend, albeit for 2014: the average term last year was 27.2 years, up from 25.8 years in 2009.

Younger borrowers

Meanwhile, Council of Mortgage Lenders data shows that the pattern applies particularly to younger borrowers. It found that in the first 11 months of 2014, those aged 30 or under accounted for nearly 60 per cent of mortgages with a loan term of more than 25 years, and accounted for three-quarters of mortgages with a loan term of more than 30 years.

Moving up the age range, terms tend to be shorter. Among those aged 31-40, 79 per cent took out a mortgage with a term of up to 25 years while 16 per cent had a loan lasting between 25 and 30 years and 5 per cent had a term of between 30 and 35 years.

Among borrowers aged 41-50, 98 per cent had a term of up to 25 years and 70 per cent had a term of under 20 years.

Of course, the older a person is, the less likely they are to take out a longer-term mortgage because the end date is more likely to extend into retirement, when their income may drop.

Yet with the average age of first-time buyers now up in the 30s, there is less margin for error. Someone who buys their first home at 35 and takes out a 35-year term will pay off their mortgage when they are 70, assuming no overpayments. This is well beyond the current state retirement age for both men and women, although by the time that person reaches the age of 70 this may well have changed.

The Mortgage Market Review, which came into effect last year, does not prohibit lending into retirement but requires lenders to ensure that borrowers will be able to afford their mortgage when they retire.

The FCA insists it has no intention of halting lending into retirement but its rules make clear it has its eye on the issue and has a level of concern.

Financial Policy Committee external member and ex-Barclays chief executive Martin Taylor has also voiced concerns on the subject. Speaking last year, he said: “One of the things that surprised me, coming back to the banking world on a different side of the table, was seeing how long mortgages had got at origin. In the 1990s a mortgage was between 20 and 25 years at origin but now it is usually up at 30 to 35 years.

“The beauty of a relatively short mortgage term is, if the borrower gets into trouble, it is reasonably easy for banks to show forbearance by lengthening it. Where we are now, with people working even into their 80s, it has become more difficult.”

Several brokers and lenders believe there is room in the market for longer-term deals. Nationwide mortgages head of product management James Broome says: “There remains a place in the market for longer-term loans. This is especially true when considering the flexibility lenders offer on mortgages now, with most lenders allowing up to 10 per cent of the balance to be overpaid each year.

“There are many borrowers for whom setting up regular payments at a slightly lower level makes sense, to keep the loan affordable within their usual budget. They then have the option to make overpayments in the months when either their income is higher or their outgoings are lower, and in doing so potentially reducing their term.”

A point made by a number of experts is that, where a client is declined for a 25-year term, a compromise can be achieved by  extending the term with the existing bank or building society rather than sending the client to a different lender, which could result in a poorer rate. Upping the term could make the difference in meeting the existing lender’s affordability criteria.

Fleming-Duffy says: “On the basis that delivery of longer-term mortgages is provided purely as the result of an advised sales process, we should not be concerned about terms being extended past this traditionally held standard of 25 years.

“Vast numbers of lenders allow mortgage terms of up to 40 years and, subject to affordability and assessment of income into retirement, perhaps we should be considering even longer terms still.

“At one time, Kent Reliance Building Society brought the Japanese-style 100-year mortgage to the UK. However, it was not well received by many journalists, industry pundits and (possibly) the regulator.

“I believe that a cultural shift away from traditional property ownership values is long overdue and the sooner we can provide innovative thought to affordable mortgages, which may indeed take two generations to pay off, the better.”

Some brokers have harsh words for regulators that they believe have failed to fully understand longer-term deals.

Boulger says: “Comments from the FCA imply it has a bias against longer-term mortgages, which suggests it doesn’t adequately appreciate that, for some borrowers, a longer-term mortgage is sensible.

“I could understand the PRA not liking to see average mortgage terms extended, as it is a macro-prudential regulator, but as one of the FCA’s objectives is to encourage better consumer outcomes, it should be more open-minded about the appropriate mortgage term.”

Historical opinion

While brokers speaking to Mortgage Strategy generally see little risk in long-term mortgages – assuming that borrowers fully understand the implications and that the advice is sound – this has not always been the case. Shortly after the comments by the PRA’s Andrew Bailey last year, Middleton Finance managing director Daniel Bailey (no relation) told Mortgage Strategy: “The industry needs to address the issue before we find out that thousands of people are stuck in this situation. I think we need clearer guidance from the regulators, or from lenders, to say where we are in terms of retirement ages.

“When lenders all have different criteria as to what age they will lend to, it becomes more complicated. The regulators should join heads with lenders and come to an arrangement that produces the best outcomes for borrowers.”

But although the market as a whole is witnessing increasing demand for mortgages with terms of more than 30 years, there are some exceptions.

Santander Mortgages head of business development Graham Sellar says: “We haven’t seen an increase in demand. The vast majority of our customers take terms under 30 years. It’s all down to personal choice and what’s best for each customer and which mortgage will meet their individual needs.”

Nationwide acknowledges a growing customer appetite for longer terms but says this has had a minimal effect on its book. Broome says: “While there may have been a small increase in the proportion seeking longer-term mortgages, the vast majority of customers continue to take terms below 30 years.”

Drivers of demand

Nevertheless, experts highlight a number of factors that are behind the general rise in demand.

First, spiralling house prices stretch many borrowers’ budgets, forcing them to seek ways to reduce monthly payments. The latest data from Halifax shows typical values soared by 9 per cent in the year to August, putting the average house price at £204,674.

Another factor is tighter affordability requirements, which mean that some financially stretched clients may have to opt for a longer term than originally planned to meet lenders’ criteria.

London & Country associate director of communications David Hollingworth says: “There are two key drivers for the rise in demand for longer mortgage terms.

“The first is the ever-present issue of high house prices, which forces borrowers to take a bigger mortgage in order to meet the purchase price. That can be particularly true of first-time buyers, who have not enjoyed growth in a current property enabling a larger deposit to be taken forward.

“Second, the MMR has rightly placed affordability at the centre of the lending decision. Where borrowers may be struggling to meet a lender’s affordability requirement, one solution could be to lengthen the mortgage term.

“Either way, some borrowers will elect to cut the monthly payment either because they need to, in order to meet affordability, or because they prefer to leave some flex in their monthly budgeting even though the overall cost will climb.

“At the last peak, many borrowers used interest-only in a similar way, keeping committed monthly costs down initially but with the intention to switch to repayment or initiate an alternative repayment strategy in the future. Taking repayment over a longer term at least means the borrower will have repaid the mortgage at the end of the term.”

The demise of interest-only lending has led many first-time buyers instead to extend their mortgage term to keep monthly payments down.

CML spokesman Bernard Clarke says: “There may be some link between lengthening terms and the contraction in new interest-only lending. Both options can make a loan more affordable for the borrower in the right circumstances.”

Boulger says: “Interest-only mortgages are no longer available to borrowers without at least six figures of equity. The next closest alternative is a repayment mortgage for as long a term as possible.”

It is indisputable that long repayment mortgages are less risky than interest-only.

“Offering interest-only mortgages to all consumers – regardless of the assessment of a suitable repayment vehicle – must be deemed to have been a fairly reckless lending strategy,” says Fleming-Duffy.

“By comparison, it is sensible for consumers, particularly first-time buyers or those buying larger properties, who are facing higher housing costs compared to previous generations to consider ways to reduce their monthly outgoings. Extending the mortgage repayment term is one of the most risk-averse, practical ways of doing this.”

Long-term implications

A key factor in choosing an extended term is that borrowers must understand the ramifications of a longer-term mortgage, which are that they will ultimately pay more interest than they would with a shorter term.

Borrowers who seek advice from a broker will of course be told this, but whether that message sinks in is another matter.

On a £200,000 repayment mortgage at 3 per cent interest, the total interest on a 25-year term is about £85,000. However, on a 30-year term this soars to £104,000, or to £124,000 on 35 years and a massive £144,000 on 40 years.

There is a strong school of thought that 25-year mortgages should no longer be regarded as the norm.

Hollingworth says: “With people working longer and higher house prices to contend with, we may see more people viewing their mortgage debt as a longer-term liability.”

Boulger points out that, without the option to obtain a mortgage with a term well beyond 25 years, clients may instead be forced to rent, which in the long run would leave them far poorer.

He explains: “The biggest consideration for most people is monthly payments, and a 30- or 35-year term might be what they need to bring the payments down to a similar level to their rent, and hence to what they can afford.

“You have only to compare the future situation of someone who carried on renting for 30 to 35 years with that of someone who bought a property with a 30- to 35-year mortgage to answer this question.

“Not only is it probable that the person who carries on renting for 30 to 35 years will pay more for their accommodation over that period than will the person buying their property, but also at the end of that time they will have nothing to show for it.”

TWENTY-FIVE IS NO MAGIC NUMBER

Ray Boulger, senior technical manager, John Charcol 

Ray-Boulger-700.jpg

In the debate about longer mortgage terms, we should stop thinking there is a default term for a mortgage of 25 years – there is nothing magic about that number.

Lenders, brokers and comparison sites should be banned by the FCA from setting a default term on mortgage calculators. If lenders and advisers had to assess each situation on its merits, rather than lazily assuming a 25-year term, more thought would be given before choosing different terms for comparison, based on individual circumstances.

The basic issue is simple and well known, not just to every competent broker but also to most borrowers: the longer the term, the more the mortgage will cost (assuming no subsequent changes), but the shorter the term, the greater the risk to the borrower of struggling at some stage to make monthly payments.

Finding the right compromise term may not be easy and will depend on many factors, not least the security of a borrower’s income and what type of interest rate is selected. So, for example, it would generally make sense to build in a greater margin of flexibility for a self-employed borrower than for one who is employed.

Discussing the most suitable term with a client is as important as discussing the type of interest rate. As nearly all mortgages allow some fee-free overpayments, more financially sophisticated clients may prefer a longer term than they think they need. This needs to be based on what they are confident they can afford and allowing for interest rate rises, on the basis that they plan to overpay and the more they do, the more options they will have if the unexpected happens and they need to reduce payments to the contracted level.

Now that even one missed payment can result in rejection for credit, or having to pay a higher rate, it is even more important than in pre-credit crunch days to build in a margin for the unexpected. This is one of the benefits of a longer-term mortgage but one has to balance that against the extra interest cost if overpayments are not made when they are affordable.

An offset mortgage is an ideal way to do this as all surplus funds can be paid into the linked savings or current account, effectively earning the grossed-up mortgage interest rate as long as they are not needed while being available on demand. Thus there is a particularly strong argument for selecting as long a term as is available with an offset mortgage – it buys extra flexibility at no cost.

Other borrowers will opt for as short a term as possible because they prefer, or need, the discipline of having to make higher payments.

If there is other more expensive unsecured borrowing, it will probably make sense to focus on paying that back as quickly as possible, freeing up some income when it has been fully repaid to make overpayments on the mortgage.

Every time borrowers change their mortgage, the question of whether to change the term should be considered. However, although a product transfer can normally be done simply – assuming the client does not want to increase the amount borrowed – a request to reduce the term may not be allowed by the lender.

The solution is simple – the client keeps the original term and overpays within the ERC-free limit – but common sense suggests that, especially after taking advice, a borrower would not ask to increase payments if they were not confident they could afford it.