The report puts responsibility for the situation squarely at the government’s door and argues there is an ethical case and responsibility for solving it quickly.
Here are the eight proposals in the report:
Government equity loans
Some prisoners, including many with interest-only mortgages, do not qualify for new loans because they do not have enough equity in their homes to meet current deposit requirements and pass mortgage stress tests. A government equity loan would bring mortgage loan to values (LTVs) down, which would open up for some the possibility of securing a mortgage in the open market through the FCA’s modified affordability assessment.
The equity loan could be interest-free for an initial period – say five years. Loans could cover a proportion of the outstanding debt, with a cap on the equity-loan amount and possibly on the value of the mortgaged property. This mirrors the approach of the government’s successful Help to Buy scheme for buyers of new homes.
The measure could be available to prisoners who are up to date with payments, have no arrears in the past 12 months and are not in negative equity. Our calculations indicate that an equity loan of up to £25,000 for those not in arrears or negative equity almost eliminated cases with LTVs over 75 per cent in the Towd Point securitisation, one of the largest tranches of mortgages sold off by UKAR.
The total up-front cost for this portfolio alone would be approximately £800m in terms of the equity loans provided; the final cost would depend on interest rate and repayment flows uplifted by house price inflation if any.
Remove Together loans as an obstacle
There are at least 17,000 ex-Northern Rock Together mortgages still outstanding. Together loans have two elements: a secured mortgage loan and an unsecured loan, both with the same interest rate. The two loans are contractually linked. Changing lenders to take out a new, cheaper mortgage breaks the link with the unsecured loan, triggering a large increase in the interest rate on that element.
The FCA modified affordability assessment allows unsecured loans to be consolidated into the mortgage as long as the interest rate on the new loan is lower than either rate on the existing loans, but many Together customers will not qualify for new loans under this scheme.
There are a few potential ways to address these loans. First, government could take the lead in negotiating the decoupling of the two loan elements. Investors would not lose out, as they would receive the same interest payments they are getting now, and prisoners would not see the benefits of switching their first-charge loans swallowed up by higher payments on the unsecured loans.
Alternatively, a government equity loan on the terms set out above could repay the unsecured element of Together loans. This would recognise the government’s earlier failure to address these particularly detrimental loans before selling them out to the market.
Partial loan write-offs by investors plus government equity loans
Refinancing is impossible for prisoners who are in arrears or negative equity, and with the post-Covid economic downturn their numbers may well grow. A combination of a partial loan write-off and a government equity loan could reduce payments significantly and allow some borrowers to remortgage with an active lender. The government cannot compel investors to write down loans but could offer incentives for them to do so, particularly if the costs of default and possession exceed the costs of the modification – as may become more likely in the current economic environment.
This approach has been used elsewhere: the USA’s Home Affordable Modification Program, in operation between 2009-2016, offered financial incentives for private lenders and investors to fund loan adjustments. More recently, evidence from Ireland suggests that owners of closed books have become much more flexible in their approach towards restructuring, with an increased emphasis on long-term restructuring to reduce mortgage balances and repayments. Some of these investors, for example Cerberus, also operate in the UK and should be encouraged to demonstrate a similar degree of engagement and flexibility when it comes to long-term restructuring here.
At a later date, if borrowers are up to date and have avoided arrears for 12 months, they would become eligible for government equity loans as set out above.
Mortgage rescue – allowing borrowers to remain in their homes as tenants
There are some prisoners, particularly those with arrears and other debts, for whom a mortgage is financially unsustainable even if the payments are reduced. Such borrowers may do everything possible to avoid losing their homes, even at the cost of going deeper into debt. For many prisoners in this situation it is not enough to reduce LTVs or enable access to a cheaper loan.
A mortgage-rescue scheme would relieve the financial pressure on such prisoners while allowing them to remain in their homes. Any part of the loan not covered by the purchase price would be written off. The government could offer financial incentives for housing associations and investors to take part. Beneficiary households would have the option to buy their homes back in future as their circumstances allowed, possibly via a shared ownership structure. The design of any mortgage-rescue scheme should build on the lessons learned from past practice and from policies in other countries.
Bring all owners of closed books within the FCA’s regulatory perimeter
Currently there is no requirement for the owners of closed books to be authorised for lending. They may therefore sit beyond the regulatory perimeter – that is, be unregulated by the Financial Conduct Authority (FCA). In such cases the administration of loans must be carried out by an authorised third-party administrator (TPA).
The current version of the FCA’s Perimeter Guidance Manual runs to over 800 pages. Because financial services are constantly developing and innovating the perimeter is not static, and the FCA now publishes an Annual Perimeter Report.
Mortgage administration covers ‘a narrow range of activities such as notifying the borrower of changes in interest rates, payments due and other matters where notification is required under the contract, and collecting/recovering payments’ according to the FCA. Given that the regulator feels it necessary to regulate these activities there seems to be little justification for leaving some customers unprotected.
The FCA recently rejected calls to extend perimeter regulation to owners of closed books. They admit that ‘where the purchaser is not regulated, our reach over the regulated administrator may not be sufficient for us to deliver the same level of protection as for borrowers that have mortgages with regulated firms’. Even so, in practice, it says, most borrowers do have sufficient protection through existing arrangements and a change in the regulatory perimeter would help only a ‘relatively small number of borrowers’.
The All Party Parliamentary Group (APPG) says all owners of mortgage loans should be regulated, and this is the approach that has been taken in Ireland. Such a change would enable the FCA to exercise greater oversight over those closed-book owners whose practices are most detrimental to consumers and would reassure prisoners that their concerns are taken seriously.
Cap SVRs on closed books
Current closed-book standard variable rates (SVRs) are a much-debated issue. Typically, they are above the Bank of England average SVR rate across the wider market, although the difference is not large.
To reduce any harm caused by the difference in SVRs, closed-book SVRs could be capped at a nominal ceiling, or a certain margin above a reference rate or the market average. This is the approach advocated by the APPG and prisoners themselves.
Our analysis suggests that the benefits to prisoners of capping SVRs at near-market levels would be small. We modelled some possible caps with data for 41,000 loans in the Towd Point securitisation. About half were paying SVRs above five per cent as of end-2018.
Capping SVR at five per cent would cost on average about £30 annually per affected borrower; the annual cost would be £600,000 for this portfolio. A cap of 4.5 per cent would cover nearly all SVR borrowers. The average remediation cost would be approximately £360 per annum per affected borrower with an annual cost £13.3 million if applied to the loans in this securitisation.
The APPG on mortgage prisoners has proposed a cap on closed-book SVRs of two per cent above Bank Rate. Such a cap would result in an SVR of 2.1 per cent, as Bank Rate stands at a historic low. This is broadly in line with market rates for new loans for low-risk borrowers, and well below the current average SVR charged by active lenders of approximately 4.39 per cent. A cap at this level would be beneficial for many prisoners but would undermine the principle of risk-based pricing that underlies the mortgage market, and we do not recommend it.
If an SVR cap were to be adopted it should apply to closed-book borrowers only. An across-the-board cap on SVRs would have serious adverse effects on the business model of many active lenders, particularly building societies that charge relatively high SVRs in order to pay higher rates to their depositors. This would have the effect of transferring harm from prisoners to savers. Even limiting an SVR cap to closed books would not be cost-free. As a retrospective change to the contractual conditions of loans held in securitised portfolios, such a measure could have negative effects on the wider securitisation market.
Provide better information
Prisoners express frustration at how difficult it is to find out what has happened to their loans, including who the current owners are. More transparency about the owners of the loans including contact details and the securitisations in which they are held would benefit all prisoners.
This information might be brought together in a dedicated web portal, perhaps the Money and Pensions Service, which should:
- Give borrowers an easy way to check the regulatory status of the legal owners of prisoner loans including both closed books and active lenders,
- Set out what protections are already in place through UKAR and the regulator. This should include an outline of current FCA powers by a simple schematic according to regulatory standing of legal owner/servicer,
- Issue a clear recommendation that Together prisoners should repay the unsecured element first.
Fund and signpost debt counselling and advice
Many prisoners have other types of debt in addition to their mortgages. This includes not only the unsecured element of Together loans, but also credit card debt, car loans, for example.
Many would benefit from holistic financial advice: evidence from both Ireland and the US suggests that loan modifications and restructuring to improve loan affordability are more likely to be successful if independent debt counselling rather than just mortgage advice is received by the borrower.
Borrowers in financial difficulty should actively be encouraged to seek independent advice; this may identify ways they can improve their financial situations so as to qualify for new mortgages in future. This could also have immense wider benefits if it could be applied to all potential borrowers.
Another group of prisoners that could benefit from debt advice are older borrowers with interest-only mortgages. They may have mortgages with only a few years of their terms left and are likely to be unable to change lender if they cannot demonstrate that they can repay the whole of their loan. Debt advice may be the most appropriate remedy.
The government could fund independent debt-counselling organisations to work with these borrowers and signpost their services to prisoners. Other influencers such as Money Saving Expert, the media and mortgage prisoner support groups could encourage prisoners to access such advice.