Compared with the volatility of the UK, the US mortgage market appears to be a model of predictability, but it is generally accepted that whatever happens in the US will eventually filter across the pond and impact on the UK. So what are the influences expected to shape the UK market in the future, and are there any factors which are unique to the US market?
Chancellor Gordon Brown is obviously keen to tap into the stability of the US mortgage market and announced in the recent Budget that he has commissioned a study into long term fixed rates, the mainstay of the US market. It is at least partly to do with long term fixed rates that growth in US property values has been steady, rather than dramatic. And, with regard to applications, the widespread reliance on title insurance has pushed lawyers to the fringes, and the standardisation of forms and procedures has improved clarity and speed.
Gerry Bell, head of customer marketing at London-based specialist lender, First National Mortgage Company, says British borrowers might be surprised by the general absence of lawyers from the mortgage process in the US. In most cases, a borrower in the US would use a real estate agent to provide access to properties, a mortgage broker to provide advice on finance, and a title company to support the purchase. It is possible to deal with lawyers, he says, but they tend to be expensive.
‘Being American,’ Bell says of the US market, ‘they have looked at the process, streamlined it and made it more cost-efficient. And it works well for them.’
The American way
The US market is also more highly segmented than the UK. Loans are routinely sold on by the original lenders and serviced by third parties. In the UK, lenders still tend to retain both the loan and the servicing.
Bell notes that securitisation has developed in the UK mortgage market. However, despite the presence of third-party service providers and administrators, he says, many major UK institutions still prefer to service their own loans. He also suggests that the strong growth and profitability of the UK market has meant that institutions have not had to think about breaking their operations into segments. But he believes tougher market conditions in the UK could make third-party service providers more attractive to lenders as there will be a drive for greater cost-efficiency.
Richard Hurst, head of communications at Future Mortgages, says the problem is that some ideas take longer than others to be assimilated. For example, standardisation of application forms has been on the agenda in the UK for 10 to 15 years, without a result. Hurst says the change would generate enormous savings just in printing and design, but believes there will not be change without a strong push from the Council of Mortgage Lenders (CML). He says: ‘There is one application form in the US. In the UK we have 120.’
Much of the standardisation within the US housing market can be attributed to the work of the two publicly traded financial services companies, Fannie Mae and Freddie Mac, whose purchases of loans from lenders have generated much of the capital that underpins the US market. Bell says Fannie and Freddie provided a strong federal focus and restored consumer confidence in the aftermath of the mortgage scandals that swept through the savings and loan industry in the 1980s.
Whereas financial institutions in the UK are large enough to drive market share, another key difference is that markets in the US are localised. In the US, banks were prohibited for a long time from expanding across state lines. Bell says these rules helped localise the US mortgage market. The bank ownership restrictions have been removed by federal legislation, but the US banking market remains relatively fragmented. On the mortgage front, Bell says, there are no national organisations to drive business and build critical mass.
Hurst notes that the force of law will replace the UK’s own voluntary regulatory regime at the end of 2004, which could open the UK market to standardisation. However, he claims the big operators in the UK might not want to standardise the market, on the grounds this would make things easier for smaller competitors and points out that large mutual organisations might find it difficult to sell their investors on the idea of hefty investments in information technology.
One result of standardisation and segmentation in the US market has been a static product mix, and the US market is characterised by long-term fixed products. By contrast, the UK is highly flexible, with intricate products that rely heavily on refinancing techniques. Hurst describes the UK market as inherently creative. He says: ‘Because there are so many competitive pressures in the UK, we are always looking for angles. The big players will stick to their game, and you get niche lenders, or smaller lenders.’
However, as has already been mentioned, lenders may come under increasing pressure from the Government to move more towards long term fixed rates, in a bid to prevent any repeat of the bust scenario.
Boom and bust
The house-price crash in the UK at the beginning of the 1990s spurred refinancing activity by encouraging people to restructure their finances. There was no similar price collapse in the US, which would have had a similar effect. Therefore, refinancing has been a prominent feature of the US market only in the last couple of years, with the collapse of interest rates.
John Malone, national mortgage manager at Prudential’s Premier Mortgage Service, says the growth of refinancing might also cause some UK lenders to consider selling loans on rather than continue to hold them.
He says: ‘Up until a few years ago, they [the lenders] were getting a fair bit of income on the back book. Now because we are all doing remortgages to an enormous degree, there is not so much value in the mortgage anymore.’
The sub-prime market, long a feature of the US sector, has only existed in the UK for the last five or six years but in the US the market is very established and there is more of a blurring of boundaries between lenders.
Hurst says: ‘UK lenders who previously might not have wanted to be associated with this market are now attracted by the potential for profit.’
The actual term ‘sub-prime’ was also adopted from the US, and UK lenders have been trying to distance themselves from it ever since. They prefer the terms ‘niche,’ ‘specialist non-conforming,’ or ‘adverse credit repair.’
One of the major differences is that the US mortgage market reflects the technology-friendly nature of the US. The internet is teeming with companies offering mortgages and advice. Around 7% of mortgages in the US are sold online from start to finish. Hurst says it is possible to submit an application online in the UK, but he does not know of any UK institution that offers the entire process online. He notes that many customers in both countries will carry out online research before approaching someone in person.
One barrier to the growth of online activity in the UK is the amount of documentation required in the house-buying process. The establishment of a truly online mortgage market would require the co-operation of lenders, estate agents, solicitors and the custodians of the Land Registry. It will also be necessary for lenders to create shared platforms.
However, while the US residential market looks quite healthy from the outside, Bell notes that the current international situation is causing some uncertainty about the overall US economy. Bell says British buyers have traditionally looked to their housing purchases to provide strong growth in equity. The tendency in the US has been to rely on the stock market. and house price increases in the US have tended to average just above inflation.’
Malone agrees that differences between the US and UK markets are underlined by attitudes towards investment. In the US, he says, the average person tends to know the value of 10 or 12 shares. In the UK, people tend to know the exact value of their own houses ‘ and the value of their neighbours’ houses.
He suggests that the main difference between the two countries is that: ‘Americans do not worry so much about the weekly value of their property. In this country, I think they do.’
The US market is characterised by long term fixed rate deals, which have been credited with the stability of the industry.
The US market is highly segmented but is more streamlined than the UK as more of the processes are standardised.
The US is well ahead in terms of online functionality, partly because of shared technology.