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Ironing out the creases

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  • 21/05/2003
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The growth in flexible mortgages has been phenomenal, but there are still some points that need to be ironed out before it can be considered a mature market

When flexible mortgages arrived on the UK scene back in 1996, there was plenty of scepticism and even criticism about these ‘newfangled’ mortgages, with many voicing their concerns about the potential adverse effects on the industry.

But they managed to weather the initial storm, and many of the lenders who criticised flexible mortgages have now, thanks to the ever-increasing borrower demand, had to re-think their stance. Many lenders now have at least one ‘flexible’ mortgage in their product range, and there are now 68 different lenders included in the flexible mortgage tables compiled by the provider of financial statistics Moneyfacts.

Gaining the knowledge

Lenders have spent a huge amount of money on marketing campaigns to raise awareness of the concept of flexibility and to educate borrowers on the benefits. In today’s society knowledge has become a valuable commodity, and mortgage borrowers are taking a far greater interest in their finances than ever before, seeking out professional advice from intermediaries as well as doing their own research. There is an abundance of information available to them, with the internet literally at people’s fingertips and countless mortgage and other financial magazines on offer, enabling them to become much more financially astute.

In addition, as borrowers’ lifestyles have changed so have their needs, and with the increase in non-standard working patterns they are demanding more flexibility and convenience from financial providers. Recent research by the Council of Mortgage Lenders (CML) found that the proportion of borrowers who say they have flexible features on their mortgage has grown from 8% in 2000 to 22% in 2002.

While take up of these mortgages is growing at an amazing rate, separate research by the CML has found that nearly half of those with a flexible mortgage have not yet used its features, either to vary their repayments or withdraw equity from their homes. Some may argue therefore, that perhaps these borrowers do not need a flexible mortgage, or even that the features themselves do not hold significant value to many borrowers.

However, this is a rather narrow view as borrowers’ needs are likely to change over time, and while they may not use the features now there is nothing to say that they will not in the future.

A simple analogy would be that of purchasing a personal computer. Most will have discovered that a computer that met their needs when they first made a purchase does not meet their needs a few years down the line as they want to do more than it will allow them to. Therefore, because taking out a mortgage is likely to be the single biggest financial commitment anybody will make in their lives, the decision should not be solely based on current financial needs, but the needs they may have as borrowers in the future.

Another of the remaining stumbling blocks is that while the use of the term ‘flexible mortgage’ is widespread throughout the industry there is still no official definition of what a flexible mortgage is.

In the absence of such a definition various bodies have had to determine their own for research purposes, and to provide guidance to borrowers. In its recent research, the CML defines a flexible mortgage as ‘¦a secured loan which can be paid back in varying installments while providing access to housing equity (within pre-agreed limits). It requires a method of charging interest that is sensitive to frequent fluctuations in the outstanding balance.’

It goes on to clarify the key features that secure the ‘flexibility’ of these types of mortgages. These are ‘¦the facility to pay off the loan early through overpayments and lump sum investments; and the facility to borrow funds back by withdrawing lump sums, underpaying or taking payment holidays.’

This view is generally accepted by the industry, and is mirrored by Moneyfacts. Moneyfacts defines the main feature of a flexible mortgage as being: ‘¦ the facility to make extra payments when you have extra money. You may also be able to reduce monthly repayments or even take repayment holidays, although you will normally have to build up a reserve through making overpayments before this arrangement is allowed. Such mortgages are usually offered on a daily interest basis. Flexible mortgages usually provide a loan drawdown facility that allows you to borrow extra funds at a set predetermined rate.’

Degrees of flexibility

If and when the industry does set out an official definition of a flexible mortgage it can be argued that there should in fact be different definitions for the different degrees of flexibility. It is clear that there is considerable variance in the level of flexibility of products on the market, and so while many lenders may call their products ‘flexible’, in some cases they are merely paying lip service to the concept.

All the lenders included in Moneyfacts’ table offer overpayments, therefore the point of distinction for flexible mortgages is the extent to which borrowers can withdraw funds from their mortgage account. Borrowers can still find ‘flexible’ products on the market that will not allow them to withdraw any funds from the account at all, nor will it let them make underpayments ‘ the flexible option is to allow the borrower to make overpayments and take payment holidays only. And while others appear to have very flexible deals, offering the full range of overpayments, lump sum withdrawals, payment holidays and underpayments, it can be easy to miss the fact that interest is only paid monthly. In addition, one would think that by way of imposing limits, such as minimum lump sum withdrawals, or payment holidays only after six months, lenders are showing an obvious disregard to any concept of flexibility.

To be truly flexible, surely a mortgage should offer all five of the aforementioned key features, without limitations and daily interest calculations? Of the 68 lenders listed in Moneyfacts, only 19 would meet this standard at the moment.

Directive opposition

For many borrowers, the beauty of a flexible mortgage is the ability to drawdown funds from their mortgage account, either within a pre-agreed limit or simply accessing overpayments that they have already made. This feature, and indeed flexible mortgages in general, has been jeopardised by the European Commission’s Directive on Consumer Credit, announced in September 2002.

The proposals contained in this Directive would require lenders to provide advice to people each time they wished to use the drawdown facility. Such requirements would be prohibitively expensive and labour intensive for lenders, who would be likely to either stop offering flexible mortgages altogether, or alternatively these products would become a lot less flexible and considerably more expensive.

Those in the industry who oppose this proposal, which is the majority, agree that it would hinder innovation and borrower choice, something that can only be to the detriment of borrowers. Extensive lobbying is expected to continue until the parliamentary committee meet in July later this year when they will put forward their recommendations. The industry can only hope that good sense will prevail and flexible mortgages will be made exempt from this rule.

If market forces are allowed to drive the future development of mortgages without the proposed European Commission’s requirements for advice, then the flexible revolution is set to continue. It is the borrower who drives the market and it is borrowers (as well as lenders) who are predicting an even more flexible future for the mortgage market. In time, we may find that flexible mortgages eventually become the norm.

This hunger for flexibility has already seen the development of current account mortgages (CAM) and offset mortgages. These take flexibility one step further and offer a sophisticated alternative to borrowers, allowing them to offset their savings against their mortgage debt, either in one account or in separate ‘pots’. As the market has become more competitive the flexible concept has extended to other sectors of the market, namely buy-to-let and, more recently, sub-prime.

But other areas are still untapped and, as the population ages, the industry is going to see equity release schemes become more prevalent. It is only a matter of time before these too are targeted by mainstream lenders, and in an effort to increase competitiveness (in the initial stages at least), flexibility will no doubt come into play again.

It is all about meeting the demand, and as the needs of the market change, so will the mortgage products on offer. But while flexible deals remain competitive with non-flexible mortgages, there is no reason for borrowers to buck this new trend.

key points

Almost one quarter of mortgages profess to have flexible elements.

Truly flexible mortgages have five key features: overpayments, underpayments, repayment holidays, lump sum withdrawals and daily interest.

The European Commission is threatening the future of flexible mortgages, but it still may be defeated.

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