Speaking to intermediaries in recent months has highlighted that some borrowers feel they are in a predicament. Will rates go up or down? Should they take out a two/three-year fixed rate mortgage or would a five-year term be better?
If they take a five-year product and rates go down, they’re stuck on one product unless they pay an early repayment charge (ERC). On the other hand, if they opt for a shorter term and rates go up, when it’s time to remortgage, their new rate will go up too.
To cater for this dilemma, we have come up with an unusual but simple solution by reducing the ERCs from the industry standard five years to just three years.
In a way, it’s a hybrid mortgage as it sits between a shorter and longer-term product. You could view it as a “three, four or five-year fixed rate option mortgage rolled into one” but that’s not a very snappy product name.
Beneficial for stress testing
Another advantage for the borrower is it benefits stress testing as the interest cover ratio (ICR) on five-year fixed rates are calculated at payrate.
As we know, taking out a shorter-term fixed rate product, i.e. anything less than five years, means stress testing is applied at 5.5 per cent or two per cent above payrate, whichever is higher. So, by offering a five-year fixed rate with a three-year ERC means more money can be borrowed using the five-year ICR calculation, but the borrower is only tied in as if their product was fixed for three years.
Variable fee structure
If you then weave into this a variable fee structure verses interest rate, it is possible to borrow even more. By paying a higher fee, the interest rate is lower and therefore so is the ICR.
When we introduced these fee variations earlier this year, eyebrows were raised, but soon other lenders were doing this too, as for some borrowers, it serves a positive purpose. It means borrowers are not so restricted and can often borrow thousands more than they otherwise would be able to.
Striving to innovate
We are constantly looking at ways to push the boundaries and help landlords fund their portfolios within the strict regulations. Removing ERCs for years four and five creates an additional tool for brokers to help more prospective borrowers.
Removing the ERCs at the latter stage of the mortgage is a way to get the best affordability for someone not feeling comfortable with a five-year fix. But there is comfort in knowing they can review the wider interest rate environment and redeem the mortgage any time after three years.
It is also a good opportunity for intermediaries to reconnect with their clients three years down the line to see if there are any better deals on the market at that time.
Once we had decided to drop the ERCs, we were able to develop this product quickly via our in-house broker portal.
