Interest rates remaining at 0.5% for more than three years has left many borrowers sitting pretty and not even thinking about switching mortgage deals. What many don’t realise is that since interest rates plummeted the mortgage world has undergone a seismic shift.
Funding is scarcer, regulation much fiercer and lenders are more cautious about who they will lend to.
The upshot for borrowers is that they may find it more difficult to meet lenders’ criteria and become so-called mortgage prisoners as they are unable to change deals.
The problem is even more acute for those on interest-only deals, with a number of lenders exiting the sector and even those who can switch to a repayment mortgage could face a large payment shock.
The final Mortgage Market Review consultation paper tries to address some of these issues with transitional arrangements. But does it go far enough? What can lenders do to help existing clients move off their SVRs? Is there any product innovation to help?
Mortgage Strategy, in association with Halifax Intermediaries, invited the brightest minds in the industry to find answers to these questions and more.
Q. How have clients reacted to SVR hikes?
Lea Karasavvas: Most consumers are pretty clued up and realise rates are not going to stay low forever. I did get a couple of calls from clients who were upset because they thought their SVR was linked to the base rate. As a broker it’s fantastic because it has increased the level of remortgage enquiries.
David Sheppard: Most people don’t understand the reasoning behind an increase in their SVR and believe it is driven by the base rate. We are not going to change that overnight and the regulator’s mantra of educating consumers on financial services hasn’t happened. There is a lack of education about financial matters. The government needs to start educating youngsters in schools, colleges and universities.
Robert Sinclair: There is a disconnect between what consumers think they have and what they actually have. It creates problems for some and opportunities for others. I endorse more consumer education and am surprised we still don’t have financial education in the national curriculum despite government support.
Ray Boulger: There is a large variation between consumers with some clued up and others knowing next to nothing. Having education in schools would be ideal but unless experts are providing it then the quality of education would be sufficiently poor that you would have to question whether it was worth doing. The question is how it would be delivered and that’s a big challenge.
Q. Have the SVR changes caused clients to remortgage?
Peter Curran: Generally, if borrowers are on low trackers they are happy – it’s just a problem for those looking to move.
Terry McCutcheon: There is a stable environment at the moment where some borrowers are happy with the rate they are on.
Curran: Bear in mind the average LTV for our SVR customers is 51% so there is a lot of equity in the property, but there are issues for some moving from interest-only to repayment. Some lenders offer part interest-only, part repayment deals and at some point when conditions change we can become more active and design something that will work for those in that situation.
McCutcheon: Five or six years ago, 60% of our business was for remortgages and it’s about half that now. Fewer people are able to move and get to their second property because they are trapped on interest-only, and it is slowing down the market. We need something innovative to get the industry moving.
Q. Are there deals available for borrowers to move to from SVRs?
Boulger: The problem with the Halifax product transfer offer was that you could only get a 3.49% rate if you had an LTV below 60%. If you were below 60% and on a repayment deal there were plenty of better options. You could even get a five-year fix at a similar rate. Once your LTV was above 60% the fixed rate was no better than the SVR.
The big problem is for interest-only clients. They may have a perfectly robust payment strategy, particularly those who are in their 50s, but they don’t fit lenders’ criteria. The focus of the interest-only changes has been on LTVs but the reduction in acceptable repayment strategies is even more of a problem.
Karasavvas: If borrowers have to move to a repayment mortgage the cost can be crippling, especially for those who are middle-aged and may have shorter mortgage terms. It is a huge jump in monthly costs for someone who is aged 50 or 55 and close to retirement.
McCutcheon: There are opportunities to remortgage some borrowers on SVRs but there are also mortgage prisoners. They will be stuck on the higher SVRs.
Curran: Most brokers understand why we had to increase our SVR because our funding isn’t linked to the base rate. We are reliant on brokers to explain to consumers why we’ve done it. With SVR rises brokers have to consider whether to use a product transfer, stick with the SVR or try to remortgage at another lender, which will depend on other lenders’ appetite for remortgage business.
Ian Wilson: The thing that surprised me when we opened up the product transfer opportunity a few weeks ago was that despite this being available a few years ago there wasn’t the readiness for the situation. It felt as though we had a lot of questions about whether clients were ready to transfer.
Q. Why have interest-only clients not switched to repayment mortgages?
Karasavvas: Some clients have been paying the maximum amount into their pensions, some have purchased buy-to-let portfolios and not streamlined them into their mortgage. Interest-only, especially among London brokers, was sold to people with big bonuses and it worked for them. The stance of some lenders has gone beyond what the Financial Services Authority wants. For example, the regulator will accept bonuses if they can be shown for a number years but lenders won’t. If you have clients paying considerable sums off their mortgage for the past few years then how can that not be an acceptable repayment vehicle?
Sheppard: For every borrower who uses those bonuses proactively there will be one who doesn’t. I’m not saying it should stay but it needs to be monitored and that creates a cost problem. Some who say they will use their bonus as a repayment vehicle won’t so it moves into dangerous territory. We could say that every payment strategy has that issue but it can’t be controlled, just actively monitored.
I remember when GMAC-RFC was in the market it wrote to interest-only borrowers every year with a questionnaire asking what their strategy was. There were five tick boxes showing what the plan could be. We adopted that when we saw GMAC-RFC was doing it.
Boulger: One of the benefits when people used to remortgage regularly was that they saw their advisers often and could review their finances. Now that business on interest-only deals is lower, borrowers are less likely to see their broker and their strategy is less likely to be reviewed.
The problem is focussed on existing interest-only clients with sensible repayment strategies but they are not acceptable to lenders as they can’t easily remortgage and are stuck with SVR rises.
Interest-only is not acceptable for everyone but we seem to be going down to the lowest common denominator I suspect for regulatory risk.
Sinclair: We have had a series of MMR papers looking at what the regulator would like lenders to do in the future but they still don’t address the transitional issues adequately enough. It has left a vacuum so we are seeing lenders adopt policies that the regulator wants in the future and applying those today. The FSA has not articulated how it wants lenders to deal with people currently sitting on a product.
Q. How can interest-only clients be helped?
Boulger: One strategy could be to look at whether interest-only deals should be priced differently to repayment mortgages. A high LTV interest-only loan is clearly more risky than its repayment equivalent but a low LTV interest-only deal is less risky than a high LTV repayment mortgage. Is it worth considering offering interest-only up to 75% LTV with a certain extra interest rate?
Curran: I think we’ve done it in the past.
Boulger: You have but no one is doing it now.
Curran: It is something we would consider. We are pretty clear that the cost of capital is driving pricing at various LTV bands.
Boulger: There is a catch 22 situation here because the average life of a mortgage pre-credit crunch was four years and it is now significantly higher. The average life of an interest-only deal will be more in terms of matching the funding with lending. Lenders will presumably have to work on the basis that your interest-only book will have a longer life than your repayment book. It must have some implications in terms of funding.
Sinclair: I’m not sure. If that pressing differential drove more volume into the market then that would be good. If it simply skims more margin with no new money then it does no good. I’m not sure changing the price would change the amount of money available.
Q. Were interest-only loans misused in the past?
Karasavvas: Interest-only has been similar to self-cert in that it has been exploited by brokers and used incorrectly. It was sold to boost affordability and many didn’t even look at a repayment loan. It has been exploited and made an effective repayment method – something that will be scarce now. If sold to the right people there should still be a market for it but because so many were looking at the minimum payment on an interest-only basis they thought they could afford it. It’s been sold incorrectly and dealing with that mis-selling of interest-only five years ago is a big problem for lenders.
Curran: Interest-only was a way of getting on the housing ladder or moving up the ladder and we didn’t do anything to discourage it. I’m sure many brokers did a lot to encourage it and house prices were rising so buyers could look forward to equity growth. There were simply not enough deep and meaningful conversations, which is why there is an issue now.
Sinclair: And you were selling it through branches as well as brokers.
Karasavvas: At the time 15% or 20% growth on house prices meant sale of property was an easy repayment vehicle.
Boulger: At a time when inflation was in double figures it made perfectly good sense to borrow money on an interest-only basis and pay it back with devalued money in 20 years. We’re in a different place now. Most first-time buyers could afford a repayment mortgage as interest rates aren’t getting any lower. The issues are around existing interest-only mortgages rather than new customers.
McCutcheon: That is where advice comes in because brokers can advise on repayment strategies.
Q. How can lenders innovate to help people move?
McCutcheon: Having an interest-only deal and a top-up repayment loan is one potential option. It is difficult for people to move now.
Boulger: I agree. More flexibility for people who want to port existing mortgages would be helpful.
McCutcheon: It’s striking a balance between treating existing interest-only customers differently from new ones.
Karasavvas: Secured loans are becoming a big thing in the industry and for some borrowers on the cusp of interest-only it may be more cost-effective to sustain an interest-only deal and use a secured loan top-up. It’s gathering momentum.
Sheppard: I have seen people looking to move to a bigger home deciding to rent their existing property and move to a rental property themselves. They have a property they are not living in, so we are creating a double rental market. It’s a weird step we’re creating if home owners are moving up the property ladder by renting.
Wilson: There is always an opportunity to innovate. The most popular we have seen is let-to-buy.
It has proven more popular than anything we have introduced to the market such as Lend a Hand or our new-build support allowing anyone to borrow the same amount on a new-build property as they have had on a previous property. They haven’t taken off.
There is still a desire in the market to move home in traditional ways. The feedback on our Second Stepper mortgage was that clients wanted to knuckle down and do some serious saving. There wasn’t a great appetite to move forward with the equity support scheme.
Karasavvas: With the Second Stepper scheme, households have a lot of debt and are using the scheme to clear it while interest rates are low. Once the debt is serviced and rates start to rise they can move on to the next step. It’s helped them in that instance but it’s difficult to get interest-only at high LTVs, so some are moving on to repayment just to get an extra bedroom and seeing costs rocket by £1,000 a month. Many are thinking it is simply not worth it.
Boulger: I suspect one of the reasons for the low take-up is because many people are not aware of it.
Wilson: It is still available and sold direct through branches.
Boulger: Nationwide offers a similar scheme, but because you have to pay around 7% and you’re already on 2.5% SVR, then the reality is that few people will take it up.
Q. Are brokers comfortable using secured loans to help clients?
McCutcheon: We’re not that comfortable and it’s not a market we want to get into. Secured loans are seen as slightly adverse and downmarket so we would rather be able to remortgage at high street lenders with sensible interest rates.
Karasavvas: Secured loans are also written slightly differently and some lenders will stretch income further. In some instances we’ve had clients doing home developments with secured loans of, say, £50,000 that adds £200,000 to the property price. They are then able to move on to an interest-only deal or reduce their interest rates. Secured loans are being used to boost the equity and bring down the mortgage rate in the future.
McCutcheon: It’s great for the LTV but if they don’t have the income they won’t be able to remortgage.
Boulger: We do some second charge loans but we refer them to another firm. Although the FSA doesn’t require brokers to consider secured loans they should be aware of them and look at the cost comparison with a remortgage. There will be clients with good lifetime rates they don’t want to lose. A secured loan could be better value than remortgaging so clients don’t lose their cheap tracker rate.
Karasavvas: There are some incredible rates that won’t be worth losing by remortgaging.
Curran: My question to borrowers on these rates is what they have been doing with the extra cash all these years.
Boulger: Many will have some cash, but perhaps not enough to remortgage.
Sinclair: Secured loans are useful for two reasons. They can protect a good long-term rate and consolidate debt when there is income. The challenge is that there are few players and it’s not competitive to make rates high.
Another challenge is ensuring that when secured loans come under mainstream regulation they don’t get caught up in the vanilla Mortgage Market Review on affordability with less flexibility.
Boulger: Secured loans don’t work for buyers because I understand that most providers require borrowers to have had their current mortgage for six months or more.
Q. What does the MMR mean for existing borrowers looking to move?
Sinclair: I hope the MMR won’t end up the way it is drafted at the moment. The way it is worded is unhelpful as it puts too much onus on lenders to find solutions. We have put forward ideas about expanding the amount of capital someone can borrow without having to evidence income in the same way or go through the same approval process. Whether lenders have that appetite is a different issue. There is a challenge for those on interest-only and self-cert deals and what we now do with them as an industry. Brokers, lenders and regulators are all complicit in getting us into this place as nobody said stop.
Consumers are sitting in a house with a mortgage and need help. Forcing them to sell might be the only way out but it is not a great advertisement for the industry. The FSA needs to create a climate where lenders can do things if they want to, but without being forced to. If we don’t the system will get clogged up. The great thing about the system 10 years ago was the flow and liquidity in the market.