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We must focus on ability to repay

Ever since the Monetary Policy Committee decided to make the first of five increases in the Bank of England base rate we have been bombarded with boom and bust stories.

The pessimists have had their chance to blast the trumpets of doom and the optimists have been able to clash the cymbals of reason.

Adding to all the confusion has been a plethora of indexes, surveys and opinions on the state and the fate of the housing market.

One thing, however, is now clear – the run of increased base rates is having an effect. We are seeing firm evidence that the market is slowing down – not accelerating towards the bottomless pit of a housing crash, but heading more toward a housing correction. It is no longer a buyer&#39s world, say estate agents.

Lenders in the main are seeing reductions in mortgage pipelines as the public comes to grips with the Bank&#39s original message that spending has to slow down.

The British Retail Consortium has urged the Bank not to increase rates further as confidence is dampening and further raises will have a negative effect on the consumer economy.

Homebuyers too are starting to take on board the serious message of affordability and the much publicised &#39what if&#39 scenario outlined in the Miles review of longer term fixed rates.

So where does the UK housing sector go from here? The big question centres around whether will we see a further rate rise before 2005 – and if so will this be a hike too far? If there are further rises we must consider the implications for brokers and their clients. And we should look at how products like self-cert, buy-to-let and higher LTV loans will be handled in a less buoyant market. As the market slows intermediaries will see fewer mortgage clients. With brokers accounting for up to 60% of mortgage introductions, they are a major part of the mortgage distribution process.

From November 1, those still seeing customers will be regulated and authorised by the FSA and the &#39know your customer&#39, &#39affordability&#39 and &#39what if&#39 scenarios will all be part and parcel of the mortgage interview.

The know your customer concept has always been important and smart brokers will already have developed a customer relationship programme and be seeing their clients on a regular basis. This approach will pay off if the market slows and activity levels drop significantly. Brokers who have depended on drop-in customers and one-off deals delivered in the mortgage frenzy of the past three years are going to suffer because the result of a slowdown will be fewer customers actively seeking mortgages.

There is an argument that the remortgage market will continue to offer business opportunities but, again, only if consumers feel interest rates and mortgage repayments are manageable. Lenders have also been looking at mortgage products closely and the recent exposés have changed their attitudes to self-certification.

Many of the major self-cert lenders have reviewed their stances, cut LTVs and reduced procuration fees in a bid to reduce exposure.

There has also been some concern that borrowers who have taken out self-cert loans at the higher LTV bands available at the top end of the house pricing curve will be stretched if rate rises continue. How stretched these borrowers will be depends on how stretched their real income is against their new mortgage payments as well as the severity of any fall in house prices. If the property market is heading for a correction then a 20% drop in house prices is not out of the question.

Having said this, all should remain well for borrowers in these stretched situations as long as they stay in employment. Negative equity only becomes an issue if a forced sale is required so stretched but employed borrowers should get by.

Some lenders face a similar concern where buy-to-let has formed a high percentage of their overall business over the past few years.

Self-cert, buy-to-let and sub-prime products are all too new in mass market terms to have passed through a recession, so any impact on these types of products cannot be known. For example, buy-to-let investors – as opposed professional landlords – who have entered the market for growth could panic if house prices fall. If they try to cut their losses by putting more properties onto the market this could, in turn, add another twist to the downward house price spiral.

On the other hand, fewer buyers could make for a stronger rental market as people have to live somewhere, potentially benefiting those holding properties for rent. Ultimately, however, most properties will have doubled in price over the recent years, resulting in low LTVs for the lender&#39s average book. Any housing price correction positioned within a non-recessionary economy should keep most lenders satisfied with their positions.

It is also worth noting that lenders have become more sophisticated in their arrears handling and those who specialise in self-cert no doubt have underwriters aware of the cardinal rule: low LTV is not an indication of ability to repay.

The thought of a 20% drop in home prices is sobering. Against the £3trillion held in housing stock, such a decline would wipe out £600m in housing wealth. The Bank knows this and is unlikely to push rates to a point that will have a catastrophic effect on the housing market.

Finally, I imagine many people breathed a sigh of relief when the MPC decided not to increase rates in their recent September meeting. Brokers, lenders and borrowers have been in a win-win situation for the past three years. Consumers have now heeded the warnings even if this took longer than the Bank would have liked. We are beginning to see signs of a slowdown. It is now up to mortgage brokers, lenders and underwriters to focus more than ever on the ability to repay.

Base rate rises in 2004

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