Negative equity, high interest rates, arrears and repossessions all mauled the mortgage industry in the late 1980s and for those doing business then, the memories are not pleasant. We have moved on a long way and today market conditions are very different. Centralised lenders have firmly established themselves alongside the mainstays of the high street, and products have developed massively due to competition.
Flexibility and innovation have led lenders to find reasons and ways to lend to people where before they were excluded from obtaining finance. While this has helped many people onto the property ladder, it has also opened up the industry to accusations that if benign market conditions slip, and we return to the dark days of 15 years ago, many borrowers would find themselves unable to meet their payments. If this happens, how much responsibility would lenders have to bear, and is it fair to say there is a danger that lenders are becoming too relaxed as regards their lending policies?
In the media there has been much said of endowment policies and their shortcomings, with projections repeatedly brought down and more and more borrowers finding themselves having to meet unexpected shortfalls themselves. There are calls from some corners that the creeping of income rate multiples being offered to borrowers by lenders is going to lead to a further raft of problems in the long term, but is this fair or merely scare mongering?
Figures from the Council of Mortgage Lenders (CML) show a steady and marked decline in both arrears and possessions. At the end of 1994 there were a total of 10.4m mortgages outstanding. Of these, 425,233 (4.09%) were in arrears by 2.5% or more. By the end of 2002, the total number of mortgages was 11.36m, and the number in arrears by 2.5% or more had fallen to 103,200 (0.92%). In 1994 just under 50,000 properties were repossessed, accounting for 0.47% of the market. The number of properties repossessed in 2002 was a shade under 12,000, accounting for 0.11% of the market.
Clearly the move towards a low interest environment has made it easier for people to service their mortgages. However interest rates alone are not enough to account for the continual fall in arrears and possessions. Between 1996 and 2002 the average rate of interest on a mortgage fell from 5.61% to 4.58%, although it was over 6% in 1997, 1998, and 2000. There is no corresponding blip in the decline of arrears and possessions for these years. As such it seems a little out of focus to become hysterical about a rise in interest rates making thousands of mortgages unaffordable.
Sue Anderson, head of external affairs at the CML, does not believe it is fair to suggest that lenders are creating future problems by enticing borrowers with over enthusiastic income multiples, and over-geared products. She says: ‘The single biggest problem in terms of arrears and problems over paying the bill is not interest rates as many people think, but unemployment. A rise in interest rates will make a difference to marginal borrowers but will not tend to push many over the edge. There is leeway built into products so that when they are being offered and suitability is being checked it is already assessed that a rise in rates can be afforded.’
So if interest rates go up, some people will be affected, but the majority will remain safe, even if a tightening of the belt is required in other areas of their spending.
David Copland, sales and marketing director at mortgage distributor Pink Home Loans, is another who believes most will be able to take on interest rate rises if they were to come. However, he says: ‘This must be tempered with the fact that any rise will seem like a much bigger leap than it did in years gone by.’ For a borrower with a mortgage rate of 5%, a rise of 1% will see him paying an extra 20% on his existing monthly payments. When rates were at 15%, a rise of 1% would only have been another 6.7% on top of his monthly payments.
While any increase would be more pronounced due to the current low rate environment, the surround borrowing that consumers have in place on top of their mortgage is also a worry. Anderson points to credit cards, store cards, personal loans and other such financial options which are readily available and have seen consumers taking on unprecedented levels of borrowing. It seems, Anderson says, to be a question not of borrowers being able to service their mortgage debt, but of being able to service their debt as a whole if the economics change.
In light of this, is it unfair to lay the blame of possible future debt problems solely at the feet of the mortgage lenders, if so many other avenues of lending are available? In light of the high levels of debt, it is now more important than ever to ensure lenders do not allow borrowers to over extend themselves. Alastair Pate, head of strategy and marketing at Kensington, says: ‘Multiples are below the levels that were seen in the late 1980s and affordability levels are good. Kensington’s average LTV is below 3 and it will not do more than 3.5 x income. This has not changed in the last seven or eight years. I think in the main LTVs are not overly high at the moment.’
Mass market appeal
It is not the case that income multiples of four, five and six are available to the mass market, although they have become a part of the wide range of products available. Andrew Moss, product development manager at Mortgage Express, spent much of the last few months working on the lender’s new product Stepladder. It offers borrowers a 100% loan on which they have to pay interest on 70%. In return, Mortgage Express takes a share of the equity growth of the house. In effect this offers borrowers an income multiple of five. Moss argues this is not irresponsible, but is instead offering first-time buyers, and those who have lost a property through relationship breakdown, the opportunity to get back on the ladder. In short it is a niche product, for only a small sector of the market. Moss says: ‘The multiples are still based on ‘3.25 x 1’ and ‘2.75 x joint’ and this has not changed in recent years. Yes we have looked at specific areas, but these are targeted and not mass market products.’ Most observers would agree that this is a welcome move as part of the huge product development and innovation that has made the UK mortgage market the most accommodating and sophisticated in the world.
Other products offering high income multiples have also found their way onto the market and the majority of products offering high income multiples are aimed at niche markets. GMAC RFC is offering an income multiple of five times income for a five year fixed rate product. Although some would argue that it perhaps leaves no buffer zone in the borrower’s personal finances, the burden of debt should reduce markedly as the borrower’s income increases over the period. And Halifax is offering income multiples of six, but again this is a fixed product over 10 years and also for those at the higher end of the earnings scale.
David Hollingworth, mortgage specialist at intermediary London & Country, expects further development of products to meet the needs of the niche borrowers. In the next few years he says a move is likely away from income multiples towards affordability and points to lenders such as Intelligent Finance, Nationwide Building Society and Scottish Widows Bank as examples. Relying purely on income multiples is seen by such lenders as crude and lacking the flexibility to account effectively for varying expenditure levels.
For Hollingworth, one of the main areas of concern is the growing amount of self-certification and the opportunity for it to be abused. Copland also believes this is an area of the market which could create problems for borrowers and lenders alike unless firmer checks are put in place.
For brokers, it is always going to be difficult to steer clients away from the short-term deals and the possibility of higher loans through exaggerated self-certification of income. But if they fail to do it, then they are letting borrowers abuse the diversity of products, which have evolved in the last few years. Regulation under the Financial Services Authority will help ensure that the borrowers are protected as they should be and that intermediaries are giving a high standard of advice ‘ which the majority already do.
Although there are products on the market with the potential to create problems, they are being offered to niche markets where there is a certain need. The products are not mass market and most come through intermediated channels, affording the borrowers advice on their decision. As Anderson comments: ‘A crucial part in the jigsaw is the role of the broker and what they can do to ensure their clients are on the right products and aware of the possible problems.’ She says this is especially true for first-time buyers and those in special circumstances. If as expected the housing market continues to slow, then the need for increased multiples should also abate and give earnings a chance to catch up. At the moment it is unfair that innovation and evolution have been misrepresented as dangerous and irresponsible.