The real challenge for many lenders in 2002, which will in turn affect the product mix, is customer retention. With the demise of overhanging redemption penalties in the last few years, lenders will find themselves with an increasing number of borrowers coming to the end of their special rate period during 2002. With no penalties to ensure these borrowers remain on a standard variable rate (SVR), lenders need to look at producing products that attract new customers as well as keeping those they already have. Different pricing for these two groups will not be a sustainable option in the longer term.
At first, the reduction or removal of early redemption charges meant the pay rates increased slightly to balance the risk of borrowers remortgaging early. However, competitive pressure has gradually brought the rates back down and this has meant lenders are now faced with a huge group of borrowers that are not profitable until they have been on the SVR for a few years. With many of these borrowers likely to remortgage during 2002 we may see a marked shift in the design of products.
The big change, and one that will not be well received by borrowers, will be the reintroduction of redemption fees ‘ certainly within the concession period and possibly beyond. It is already acknowledged that many lenders are already looking at the reintroduction of these terms over the next year to ensure that new borrowers will become profitable for lenders in the long term.
The fact that very little money has been made on new lending over the past year to 18 months means the only alternative to the return of early redemption charges is less attractive rates. Likewise, lenders may also become increasingly careful about who they lend to. This increased reservation will not have anything to do with the credit risk of a borrower, but more to do with the risk of the borrower being a ‘rate tart’š (an individual who will jump from product to product to get the best rate). Lenders will be carefully analysing the recent history of borrowers to see if they have been moving from mortgage to mortgage. They may be less inclined to lend to them if there is evidence of frequent remortgaging rather than house purchase. Although the remortgage market is a growing area, lenders are unlikely to want borrowers they know will be unprofitable. Combined with the reintroduction of overhanging redemption penalties, these borrowers will find it increasingly difficult to move lenders for their own benefit.
Making a comeback
Another important development in the mortgage market is the possible reintroduction of mortgage indemnity guarantee (MIG) or higher lending risk fee by lenders. Again, competitive pressures have seen many lenders reduce the frequency of this charge by raising the loan to value threshold from which this applies, or removing the charge completely. Where a premium is charged, this can usually be added to the mortgage loan at the outset, rather than having to be paid as an additional fee at completion. This gives the benefit of reduced outgoings initially, although interest will be charged on any amount added to the loan. With property prices potentially tailing-off or stabilising during 2002, it may be that lenders need to reintroduce the fee in order to protect themselves from potential negative equity in the future.
In the early 1990s there were many instances of lenders’ losses being paid by insurers and borrowers being pursued for the amount of the claim. In the current climate it would be easy to think the need for MIG has gone away. It is important not to forget the lessons of the past and advisers need to ensure their clients fully understand the need and implications of mortgage indemnity coverage.
The buzzwords for lenders in 2002 will be good volume and good margin. Individual lenders will continue to seek market share from time to time, with loss-leading products, but there will not be an all-out battle to secure business unless it is profitable. As a result, we will continue to see base rate trackers in the market with a set margin over base rate. It is unlikely the base rate will fall much further over the next year and may possibly begin to rise in the latter part of 2002 ‘ some cynics would suggest rates can then be lowered in time for the next General Election in a few years time. If rates do stabilise or rise, we may see the reintroduction of more fixed rates although, as with other products, they are unlikely to be as low as the fixed rates we have seen in the past as lenders strive to retain margin. Overall the general emphasis in the market will still be on shorter-term special offer products lasting between 18 months and two years to take advantage of the current interest rate climate.
Exploring new markets
One area for new product development during 2002 is likely to be equity release. This area is likely to grow for a number of reasons. The UK currently has an ageing population, many of whom have benefited from consistent property inflation in the past. Combined with this, many individuals with personal pensions face the prospect of much lower pension income, as annuity rates continue to fall. There is likely to be a large part of the population who may not have an adequate pension and are looking to bolster it with equity tied up in their property.
Northern Rock and Norwich Union are both big players in this market and we are likely to see some new entrants keen to take advantage of this growing sector. In the last 60 years, there has been a three-fold increase in the number of over 65s. During 2000, the equity release market was worth over £500m and experienced 35% growth during that year. The predictions for growth in this market are substantial with Northern Rock estimating a market value of £3bn by 2004 and the proportion of households using equity release quadrupling by 2006.
The market is split into three distinct groups. First, those needing extra cash to get by, or make essential repairs to the property; second, individuals who are reasonably well off, but need a supplement to maintain their lifestyle and third, those with a large estate looking to decrease the amount their beneficiaries will have to pay in inheritance tax. The amount of interest a borrower will pay is dependent on prevailing interest rates and a lender will be repaid the loan when the property is sold, or when the property owners enter a nursing or rest home. This is a longer-term strategy for the lender, but the margin is higher than in the purchase market. It gives the lenders asset growth rather than immediate income and, importantly for them, a customer base to which they may be able to sell other products, probably on an investment basis.
2002 is set to be the year lenders regain control of the mortgage market. Until now mortgage products have been focused on giving the borrower what they want in terms of flexibility, rate and freedom to move. This means the lender has lost out on profitability. Although all these features will remain important to lenders when designing products, there will be a focus on ensuring lenders can retain customers and enhance their profitability. This means we may see the return of some features that are not viewed as being in the borrowers’ best interest such as MIG or redemption penalties. We may also see the introduction and expansion of other income streams such as equity release where the lender has a guaranteed profitable return on the loan.
As pressure on margins continue, lenders may reintroduce overhanging redemption fees and MIGs.
Lenders may refuse to lend to borrowers with history of frequent remortgaging.
With many homeowners needing to increase their income in retirement, more lenders will look to the equity release market.