Choice in a shrinking market

The UK mortgage market has shrunk considerably in the past year. September saw just 33,000 mortgage approvals - dwindling near historic lows. Gross lending is estimated at £260bn for 2008 - around £100bn less than 2007 - and net lending for the year seems set to reach just £50bn, while 2009 looks bleaker still.

The spirit of competition which fostered affordable deals for customers at the peak of the market has now virtually disappeared.

With balance sheets in need of rebuilding, lenders’ priorities have changed. Volume is no longer the order of the day. Instead, repairing their balance sheets and capital ratios is now the primary consideration for nearly every bank on the high street.

The specialist end of the market is almost unrecognisable compared with a year ago and many lenders are sitting it out. Some of the industry’s best known names have either fallen from grace, changed their business models or are simply twiddling their thumbs.

Although it might seem that the days of the mortgage market are numbered, this is not so – it is simply that the rules of the game have changed and lenders, intermediaries and borrowers must relearn how to play it.

We recently released research which analysed the changing state of the market. More than half of the intermediaries surveyed said that appropriate products for customers were sometimes not available via brokers.

Lenders are having to rethink their distribution channels and although brokers’ share of the market has remained fairly stable, dual pricing is often cited by brokers as a point of concern.

But differing pricing strategies have always been a feature of the market and the intermediary channel has always been about choice. In a contracting market brokers are far better able to locate good rates for their customers than are borrowers themselves.

In a market that has seen the number of products available fall by 85% from 15,599 this time last year to around 2,340 now, borrowers need all the help and advice they can get. There is an opportunity here for brokers to augment the service they offer. In-depth fact-finds and high quality advice will not only help borrowers to secure deals suited to their financial situations, it will also produce more robust loans which perform better for lenders.

The abrupt decline in mortgage finance has hit home owners with smaller deposits and less than perfect credit scores hard. The increase in arrears and repossessions is tangible evidence of tougher lending criteria and higher rates.

As borrowers remortgage, any shortfall which takes them off the coveted prime list and brands them higher risk may prevent them from getting competitive mortgage rates. Segments of the mortgage market not classed as prime are now suffering pariah status, with sub-prime being seen as the most extreme example. But the non-prime sector is now more important than ever to the health of the overall market. The number of borrowers being bumped onto lenders’ SVRs – which are often linked to LIBOR – is growing as lenders review their criteria. With three-month LIBOR still a whopping 1.3% higher than Bank of England base rate, some borrowers still face a jump in payments when they come off fixed rate deals but at least the situation is better than it was a few months ago.

As things stand, the number of repossessions in 2008 looks set to be around 40,000 and as the economy contracts, unemployment rises and discretionary spending falls, the number of people unable to afford their mortgages will inevitably rise.

In the past, the specialist end of the mortgage market catered for borrowers whose financial circumstances were less than glowing. Now there will be more borrowers who just miss out on the new prime criteria and are pushed into the non-prime market. The specialist end of the market should be taking up the slack. These borrowers need somewhere to go but the lack of wholesale finance has meant non-conforming lenders are unable to fund any new lending at all.

This is the one question the government, the Financial Services Authority and the BoE have failed to address. The liquidity measures they announced in early October are laudable and should go some way towards helping banks rebuild their balance sheets, boost confidence and lower interbank lending rates, but the future of the specialist sector remains unresolved.

Many of the independent, so-called ‘non-bank’ lenders established in the past 10 years depend on wholesale funding. As it stands, the BoE’s Special Liquidity Scheme will not accept assets written by these lenders as collateral and without support from the authorities, this sector has been contracting sharply at a time when demand for its products is growing.

What has been overlooked in the programme of action around the banking sector in general and the mortgage market in particular is that the non-prime sector has been key to the health of the prime sector. It has provided a way out for those with weakened credit histories and a way in for those who started there but have now improved their financial situations. It has provided vital flexibility and without it, the stresses in and around the prime market will grow.

The government is growing more vocal on the responsibility lenders have to keep people in their homes – its protocol on arrears and repossessions, designed to avoid premature eviction, was implemented in November.

Lenders are working hard to treat customers in financial difficulty fairly but the non-conforming mortgage in-dustry could do most to help.

The most efficient way to keep people in their homes is to ensure they can get affordable mortgages. If the government is serious about helping lenders to avoid repossessions it should support lenders that provide higher risk customers with products they can afford.