Second chance

Lenders and the Government must do more to help second steppers stuck on the first rung of the property ladder because without their help, first-time buyer movement will come to a virtual standstill

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The plight of first-time buyers is often cited as one of the main reasons behind the current stagnant mortgage lending figures, with the Government focussing much of its efforts on helping those trying to get on the first rung of the housing ladder.

Yet some would argue there is one segment of the mortgage market in a far worse position than first-time buyers – second steppers.

The phrase second stepper was first coined by Lloyds Banking Group in January 2011 to describe borrowers who had fallen into negative equity and were trapped in their first home as a result of plummeting house prices.

It invented the phrase in conjunction with the launch of its equity support scheme, which allows borrowers in negative equity to move to a property of the same value, downsize, or buy a bigger property – as long as they don’t increase their existing levels of borrowing.

At the time of the launch there were questions raised as to why the UK’s biggest mortgage lender had chosen to focus its attention on the second-time buyer market when first-time buyers were widely seen as the ones who needed the most help.

It argued that to achieve a sustainable housing market there needed to be movement throughout the market: and that if second steppers get stuck on the first rung, movement at the bottom half of the ladder comes to a standstill.

First-time buyer numbers have only recently started to show signs of real improvement. The latest figures from the Financial Services Authority show the number of mortgages sold to first-time buyers for properties worth between £120,000 and £250,000 increased 53 per cent between the second quarter of 2011 and the first quarter of 2012.

So as demand from first-time buyers slowly edges upwards and lenders start to relax their LTV limits, isn’t it time lenders and the government started looking at what properties potential first-time buyers are going to buy?

Because if second steppers are unable to move on then the increase in first-time buyers numbers could soon come to an abrupt halt.

The problem

In its Mortgage Market Review, the FSA estimates that up to 15 per cent of those who borrowed between 2005 and 2010 could be in negative equity, including up to 30% of former first-time-buyers, with borrowers who took out high LTV interest-only mortgages at the peak of the market being the worst affected.

“Second steppers who bought close to the top of the market are in a worse position than first-time buyers,” says John Charcol’s senior technical manager Ray Boulger.

“If they bought between 2004 and 2007, unless they bought in London or the South East where property prices have performed better than average, they are likely to have seen the value of their property decline. Anybody who took out a 100 per cent LTV plus mortgage or even 90 per cent LTV is arguably in an even worse position than first-time buyers.”

A recent report from Lloyds TSB found that the average price of a typical second stepper home stood at almost five times their gross annual average earnings in June 2012 – the second highest ratio since records began 25 years ago. This affordability measure has risen significantly over the past decade from 3.2 in 2002 and is well above the long-run average of 3.3.

“The challenges facing those attempting to take their second step on the housing ladder are at their toughest for more than a generation, says Lloyds Banking Group director of intermediaries Mike Jones.

“Our most recent research shows that it’s more difficult to move up the ladder than it is to get on it in the first place. Some of the key barriers which they face include raising a new deposit, finding affordable property, the general cost of moving and an overall decline in affordability.”

In addition, the same study found that potential second steppers in 2012 are estimated to be in a positive equity position of just over £9,000 on average, which would account for just 5.4% of the value of the typical second stepper property – £165,565.

This compares to a peak in 2005 when second steppers where able to fund almost half – 44%, of their next home from the equity built up in their first property.

“I am always surprised at clients’ naivety and ignorance about the current state of the mortgage market regarding how much their house is really worth, many are still working to 2008 models,” says Emba sales and marketing director Mike Fitzgerald.

“You can almost generalise, the first-time buyers who were sold the two-bedroom apartments by developers overlooking a cleaned up canal paid way over the odds and are now in negative equity, while the ones who bought a
traditional two or three bedroom terraced house haven’t really suffered -in fact some that bought the older houses and worked on them have actually increased their value.”

Log jam

Many of the properties sold by developers were new-builds, which some would argue were overvalued during the boom years and subsequently one of the main culprits of negative equity. It is perhaps surprising that the government and lenders seem to be focusing their resources on getting this part of the market moving again.

Much of the government’s effort to date to boost the mortgage market has focused on its shared equity scheme FirstBuy, which it launched in June last year and its NewBuy scheme, which launched in March this year.

It recently announced a £280m extension of its FirstBuy scheme as part of a raft of new housing and planning measures.

Under the scheme, the government and house builders offer first-time buyers a low-cost 20 per cent equity loan to boost their deposit, with a 5 per cent deposit needed from the borrower. The scheme however is limited to those looking to buy for the first-time and does not offer any assistance to those who cannot save enough to move out of their first home.

The NewBuy scheme went some way in recognising the problem of second steppers with the Government making it available to existing buyers as well, but it failed to open it up to old properties as well as new.

In its Residential Policy research paper in May, the Royal Institution of Chartered Surveyors claimed: “NewBuy has the potential to distort the market by reducing demand for second hand property and adjusting lenders’ affordability calculations.

Without stimulating the second hand market as well as new build, chains and overall transaction levels will stagnate. A mortgage indemnity scheme that works for the whole market is required.”

The Government’s Stamp Duty exemption for homes under £250,000, which came to an end in March this year went some way in providing help for second steppers and did provide a temporary boost to gross mortgage lending figures but apart from this, help for existing homeowners has been sparse.

“The market has always focused on how to help first-time buyers but unless a first-time buyer is buying a new-build they need to buy property from a second stepper, so unless you get that part of the market moving then a log jam will be created,” says SimplyBiz Mortgages chief executive officer Martin Reynolds.

“Historically people would have a property for three to four years, create some equity in it and move up the ladder. What we have at the minute is second steppers moving half way back to being first-time buyers with regards to having to find a deposit because their property has fallen so much in value.”

What needs to be done

One way lenders are hoping to boost the mortgage market is through itsFunding for Lending scheme which launched on August 1.

For every £1 of additional lending made, a bank will be able to access an extra £1 of cheap funding from the scheme.

One way in which lenders could help second steppers is to increase the overall LTV they are willing to lend at, which would give borrowers the chance to pump some money into their homes and reduce their negative equity.
“High LTV lending remains an area that is underserved and clearly there is demand from different sectors of the market, not just first-time buyers.

More options of straightforward high LTV mortgages would therefore help and perhaps lenders will start to expand their options for borrowers that can already demonstrate their ability to manage their mortgage, rather than concentrate on first-time buyers,” says London & Country’s associate director David Hollingworth.

“Some lenders have developed products that offer high LTV lending by enlisting the help of a parent. For example the Aldermore Family Guarantee mortgage allows as much as 100% lending with a collateral charge against equity in the parental property. Others have a similar approach,” he says.

Whether there is a need for bespoke second stepper products is debatable.

“I’m not totally sure that Lloyd’s borrowers will know that the option is available to them and I would be surprised if it has been particularly popular,” says Trinity Financial product and communications manager Aaron Strutt.

“I think it’s difficult to help borrowers in negative equity or those without a deposit.  If more mortgages with a per cent deposit were made available, I think we would see the housing market to start to fee up.”

Breaking out of negative equity

While Lloyds Group offers a scheme specifically targeting second steppers, this does not mean that others are not willing to help those in negative equity.

“As a responsible lender, we look at all mover applications for borrowers who are in negative equity on a case by case basis. While we don’t offer specific deals for borrowers who are in negative equity, we would consider all proposals from existing borrowers looking to move where there is no increase in their LTV or loan amount,” says a spokeswoman for Santander.

The situation for some homeowners has become so extreme that they have decided to abandon their properties and start afresh.

“The only way for some to really get out of negative equity is through the rental market,” says Fitzgerald.

“Some are deciding to rent out their property and get a deposit for their next property from the bank of mum and dad – if the figures stack up they are moving out and the rent is taking care of the mortgage.”

But even if second steppers do manage to pay off some of their negative equity, first-time buyers may still inevitably bring down the asking price of the property.

“Second steppers will require a price to be reached for their property in order to be able to make their onward purchase, so rather than it being a case of being unrealistic in their pricing it simply becomes a case of necessity,” says Hollingworth. “But first-time buyers will hold out for lower prices, which leads to something of an impasse for the second stepper looking for alternatives, such as letting their current place.”

Burden of regulation

Lenders may be more averse to risk then they used to be but the situation is not helped by the burden of regulation on banks.

“The situation is made far worse because of the regulatory situation and the large amount of capital lenders have to set aside for lending above 75 and 80 per cent LTV,” says Boulger. “It does seem ironic that all these regulatory rules which the government has signed up to make it more difficult and expensive for lenders to offer high LTV mortgages. If the government believes this is the correct approach then fine, but to sign up to these rules than come up with other schemes to get round them seems ridiculous.”

The government is under increasing pressure from voters to come down hard on banks and not let them create another boom and bust housing market and lenders are shying away from creating headlines about the return of the 100% LTV mortgage, so is there a solution?

“If the borrower is in negative equity over time they just need to keep their head down and save as much as they can,” says Fitzgerald. “There is a way out for them but it is not today – there is a bit more pain to go through at the moment.”

Brian Murphy, head of lending at Mortgage Advice Bureau

The problem for second-time buyers is gradually becoming more apparent. Mortgage lending criteria has tightened since they first bought leaving many of them effectively stuck and this is also exacerbating the problems for potential first-time buyers and those higher on the ladder who wish to sell.

House price surveys are still showing pockets where prices are still falling and, even if they have been regularly paying down their mortgage for the last few years, first-time buyers are unlikely to have made a significant dent in the capital they owe.

In the meantime therefore, lenders need to take a more pragmatic approach to second-time buyers. Many of them will have been excellent borrowers who have shown commitment and an ability to pay – with no arrears or missed payments. And in many cases their incomes will have increased and affordability will have improved. Yes, lenders are constrained by capital requirements but they need to try and think outside the box here.

It is not unreasonable to expect lenders to help those who’ve seen their equity shrink through no fault of their own. A simple solution would be to offer them higher LTV loans. Nationwide offers a 95 per cent LTV deal which can be used for this purpose and it is to be hoped that others will follow its lead.

There is even a good argument to say that there should be discretion for the LTV to be even higher. There was a lot of negative publicity about 100 per cent plus LTV mortgages in the past, but they weren’t offered to everyone and borrowers had to fit very tight lending criteria.

As such the vast majority of 125 per cent LTV deals are not in arrears and the borrowers have been making all the repayments. If they are in negative equity then there is a good argument to say they should be allowed another 100 per cent plus deal.

The constraints imposed on lenders are well documented and have understandably seen them become more cautious with criteria, but these products would only be targeted at those who have a track record of repayments. As long as they can show it is not inappropriate lending then they should be encouraged to help this group of second-time buyers.

The Government and the regulator have a role to play and need to consider a wider framework, which possibly includes state backed mortgage indemnities.

Acting as an insurer of last resort for lenders looking to take on this increased risk would encourage more participation. It has backed shared equity schemes, so there is an argument to say it should also look to back lenders in this situation. In reality they would only ever be called upon in a tiny proportion of cases.

If we can’t do something to un-stick second time buyers then the entire market will suffer an extra drag which will hold back the recovery.

Peter Williams, executive director, Intermediary Mortgage Lenders Association

Giving more support to second-time buyers is an important issue at the moment for both mortgage lenders and the market as a whole and it will continue to be vitally important into 2013.

First-time buyers typically stay in their first home for around four to five years and many will have bought at the peak of the market in 2006-2008 with high LTV loans. Since then we have seen a period of real falls in house prices, with the rate of inflation increasing faster than house prices and in many areas actual declines in nominal prices bringing the spectre of negative equity back into the market.

Even if they have been consistently making repayments, falling house prices could mean they find they do not have enough equity left to remortgage to a larger property as there are still very few deals above 90 per cent LTV.  

At the moment options remain somewhat limited and so if an owner doesn’t need to move then they could be best advised to stay where they are and wait for house prices to increase.

The knock-on effects however are that it reduces the number of homes open to potential first-time buyers as it reduces the supply of suitable properties at the bottom of the market and at the same time it reduces demand and therefore prices, higher up the market.

Transactions fall and the market becomes less liquid. For those who have to move in the short-term there is limited help available. In the past there have been negative equity schemes that allow people to move and to carry the debt with them, but lenders are more cautious now and appetite to offer such products is limited at best.

Realistically, someone in negative equity would be unlikely to get a loan from any lender other than their own.
IMLA members are very aware of the issues and it is an area that has come under serious discussion though there are no easy answers. With all the uncertainty among lenders over new regulatory and capital requirements, the lack of funding and the weakness of the economy options are limited. 

There are not many lenders currently offering higher LTV loans and negative equity and high LTV loans in a static or falling market don’t sit too comfortably together. While the Government has shown an appetite to address housing issues, this remains an area where we have seen little progress to date even though it is crucial to the health of the market overall.

The focus remains doggedly on first-time buyers and the problems faced by existing owners seems to have gained little traction. At the moment the Government appears to favour the use of guarantees and this could be used to help to second steppers and not least those with negative equity.

The regulator recognises the problems of trapped borrowers though perhaps not in these precise circumstances and it could go further by making special provisions for lenders dealing with borrowers in these circumstances.

The upshot is that we have a growing friction between housing requirements and the economy as a whole with numbers of existing owners unable to move. This then impacts upon the labour market and on the efficiency of the wider economy.

Sue Anderson, head of member and external relations at the Council of Mortgage Lenders

According to research from Lloyds TSB, the typical second stepper has equity equivalent only to 5% of the value of a typical second stepper home, compared with almost half in 2005, so moving up the property ladder looks a lot more difficult than it used to.

The main reasons for this relate to house price fluctuations.

Although the UK has been relatively fortunate in terms of escaping the kind of house price crash at a national level that some economists feared when the credit crisis took hold, there is a huge amount of regional variation and at national level house prices have not helped consumers to build up equity.

So what could break the logjam, both for the industry and for consumers?

Here the answers are more difficult, because they don’t necessarily lie within the gift of market participants.

Consumers can’t easily just magic up bigger deposits – although a remarkable number of people – and not just first-time buyers, seem to be continuing to find the bank of mum and dad an important source of deposit funds.

Lenders also can’t just turn on the tap of a large increased flow of lending at higher LTV ratios, not least because capital considerations are a significant constraint – albeit one that neither government nor media commentators always seem to remember.

To illustrate that point, a lender has to hold around five or more times the amount of capital on a 95 per cent loan as on a 60 per cent loan.

In a world where capital remains precious, it can hardly be a surprise to find that high LTV lending is squeezed, as lenders are caught between the choice of undertaking very little lending at high LTVs, or more lending at lower LTVs.

And that’s just capital. Second steppers with modest deposits will also have other considerations in their minds.

What will house prices do next? Is it better to stay where they are, albeit reluctantly, with a higher equity cushion, or to move up and have a lower proportion of equity and hence, a more expensive mortgage deal? And for their lenders, the same questions apply.

If they lend and house prices wobble, the borrower is left with little skin in the game and the motivation to keep paying the mortgage may be eroded.

Does that feel like responsible lending, especially if no-one else is doing it? Does it meet regulatory expectations?

Even so, it is testament to lenders’ commitment to the market that they are continuing to innovate to help borrowers who don’t have huge deposits.

As well as individual lender schemes, there is also NewBuy and there is also the Local Authority Mortgage Scheme, administered by Capita, which is working with a number of local authorities and lenders, to increase the availability of higher LTV lending at a local level.

Lenders are firmly attuned to the problems faced by those without a large deposit.

But regulation – especially capital requirements – is not making them easy to solve. When risks are mitigated – such as through indemnities – capital relief ought to be forthcoming.

The market would benefit if capital relief could be achieved more readily.