Market review

The lay of the land

Craig Calder

director of mortgages, Barclays

As we hit H2 2022, it’s certainly been an interesting and challenging six months for lenders. On the back of five consecutive interest rate rises, swap rate swings, and a host of influencing factors extending far beyond UK borders, in days gone by it wouldn’t have been too much of a stretch to find a marketplace shrouded in pessimism. The UK housing and mortgage markets are in a far more robust place than in earlier times, however – and, despite some bumps in the road, I think it’s fair to say that they have performed admirably over this period and continue to exceed expectations.

MORTGAGE BORROWING

This impressive performance was evident in the Bank of England’s latest money and credit data from a mortgage market perspective after it outlined that net residential mortgage borrowing increased to £7.4bn in May, up from £4.2bn in April, to sit above its 12-month pre-pandemic average of £4.3bn.

Gross lending increased to £28.4bn in May from £26.7bn in April, while gross repayments rose slightly to £21.8bn compared to the April figure of £21.6bn. Mortgage approvals for May also ticked up from 66,100 to 66,200, although this was slightly below the 12-month prepandemic average up to February 2020 of 66,700. However, unsurprisingly, the effective interest rate paid on newly drawn mortgages increased by 13 basis points to 1.95 per cent in May, while the rate on the outstanding stock of mortgages ticked up two basis points to 2.07 per cent.

Of course, some degree of caution has entered the market in recent times on the back of rising inflation and amplified living costs. But, to stay on a positive note, demand remains strong, and the reliance on the advice process continues to climb for a range of borrowers in what remains a competitively complex lending landscape.

HOUSE PRICES

Turning our attention to house prices, following two years of unprecedented growth, property prices are suggested to be experiencing the lowest rate of monthly price growth since December 2019. The latest Zoopla house price index highlighted that average property prices were broadly unchanged in May, up 0.1 per cent, as the pace of price inflation loses momentum. Annually, property prices are suggested to be up 8.4 per cent, compared to 9.2 per cent growth in April, with quarterly growth at 1.4 per cent – the slowest since March 2021. The data also showed that buyer demand is still higher than the five-year average, but it continues to decline week-on-week in a return to more usual levels of demand.

Despite a slightly negative air to these metrics, such stability in what remains an uncertain economic climate really is testament to the continued strength of our housing market. In the wake of recent interest rate rises, and increasing speculation about further ones, it‘s certainly not all doom and gloom when it comes to mortgage-related activity. Opportunities continue to present themselves for advisers in many areas, especially in a remortgage sector that is experiencing heightened demand from homeowners looking to, in the main, secure lower payments and longer-term fixed rates to help limit and stabilise their outgoings.

REMORTGAGE

This consumer imperative was evident in the latest figures from LMS, which pointed to a remortgage surge of 73 per cent in May, with this expected to increase further in the coming months. Of those who remortgaged in May, 63 per cent were reported to have taken out a five-year fixed rate product, with 26 per cent saying their main aim when remortgaging was to lower their monthly payments, which represented the most popular response.

Rates do remain competitive for such products, but, with affordability constraints increasingly evident, borrowers are – quite rightly – relying heavily on mortgage advisers to secure the most appropriate deals at the best rate. This trend is only likely to continue as the mortgage market becomes even more complex.

AFFORDABILITY

When embarking upon a lending review, it would be remiss of me not to highlight an important announcement from the Financial Policy Committee confirming that it will withdraw its affordability test recommendation. This will come into effect from 1 August 2022.

Introduced in 2014, the test specifies a stress interest rate for lenders when assessing prospective borrowers’ ability to repay a mortgage. The other recommendation, the loan-to-income (LTI) ‘flow limit,’ which will not be withdrawn, limits the number of mortgages that can be extended to borrowers at LTI ratios at or greater than 4.5.

The recommendations were introduced to guard against a loosening in mortgage underwriting standards and a material increase in household indebtedness that could in turn amplify an economic downturn and so increase financial stability risks.

The fact is that we are operating in a vastly different lending landscape from that of 2014, when the test was first introduced, and it’s vital to reiterate that this withdrawal will certainly not open the doors to a host of irresponsible lending practices. Individual lenders will maintain their own levels of stress testing and appropriate risk appetites, although it’s always prudent to monitor closely any impact this move may have in the near future. M I

Disappearing acts

Richard Rowntree

managing director for mortgages, Paragon Bank

The current economic climate means that lenders are being forced to make quick decisions, so it’s important for borrowers and brokers alike to understand why the rate they see today may not be available tomorrow.

The last few years will surely be remembered as some of the most economically volatile in modern times. Here in the UK, the fiscal fallout from Brexit was still being felt when the COVID pandemic rocked economies around the world, followed quickly by Russia’s invasion of Ukraine.

Each of these once-in-a-generation events, happening in relatively quick succession, has contributed to unstable market conditions. Lenders are constantly reacting to the market in order to protect both their businesses and customers.

Understanding some of the factors driving this can assist in informing conversations with clients, hopefully helping them to make informed decisions and minimising frustration that understandably arises when a product is suddenly withdrawn.

Particularly useful here is a basic understanding of swap rates.

Swap rates refer to the price paid by lenders to other financial institutions to fix rates offered to customers, over an agreed period, usually two, three, five, or ten years.

When lenders offer mortgages with interest rates that are fixed over a certain period, their returns are at risk of being negatively affected if the cost of funding rises. The swap rate helps to mitigate this risk for lenders by locking in a cost of funding over the fixed period, with this financial security incurring a cost.

Swap rates are derived from the market’s expectations of what interest rates will be over the term. This means that as well as the Bank of England’s base rate of interest, events like global health crises or major conflicts can all have an impact, alongside changes to supply and demand for essential items like food and energy.

An important point to note is that swap rates are constantly in a state of flux, changing by the second, so in a market as unsettled as the one we’re experiencing currently, lenders are being forced to re-price products frequently.

If they don’t do this, they can find that the margin on the product they were offering has suddenly been slashed. This effect can also be exacerbated by the delays in the system that we have seen since the surge in activity caused by the stamp duty holiday.

A lender can agree a mortgage at a given rate, but with other parts of the process, such as conveyancing, sometimes taking months to complete, the swiftly moving market may mean that the previously competitively priced product is now making for a loss.

While withdrawing products can lead to frustration for brokers and clients, such losses are clearly unsustainable – a thriving industry is better for everyone, so it is unfortunate to see some lenders forced to suspend their buy-to-let lending due to what they’ve called unprecedented increases in the cost of funding.

And it isn’t just about lenders’ bottom lines; if products are priced well below those offered by the rest of the market, they attract surges in business volumes that are not possible to process within acceptable timeframes, leading to poor service – again, to the irritation of brokers and borrowers.

Of course, this is very much a simplified look at a complex issue. While it’s probably not necessary for mortgage intermediaries to know the nuances of how different lenders are funded and how this influences the products they offer at any given time, I think brokers can benefit from having a basic grasp of the subject.

While we don’t want clients to feel like they’re being given the hardsell, “Don’t delay, buy today!” line, we do need to help them understand why the current extraordinary economic climate means that the products they are offered today may not be available tomorrow. M I

Financial hot water requires cool heads

Stuart Miller

chief customer officer, Newcastle Building Society

Every so often something major changes the dynamics of the mortgage market significantly. In the late 1980s, it was the end of endowment policies. In 1997, it was relaxing tenant-rights rules to encourage buy-to-let. The early 2000s saw loans-to-value climb to 125 per cent; the crash in 2008 triggered the end of self-certification and the introduction of affordability in place of simple loan-to-income ratios.

This year, we are seeing another shift in how the market operates. In seven months, the Bank of England (BoE) has hiked the base rate from 0.1 per cent to 1.25 per cent. Further hikes are expected in short order.

Mortgage rates are rising faster now than at the start of the year. The cost-of-living crisis faced by millions of households in the UK is already biting into disposable income and is set to get worse as inflation may rise to over 11 per cent in October, according to the Bank of England’s forecast. While arrears remain at historically low levels, very early indicators of stress such as repayment requests to change direct debit arrangements have begun.

It has been decades since the UK economy faced the threefold challenge of stagnant growth prospects, wage inflation, and a rapid rise in living costs. Economists continue to argue over whether the coming recession will echo the reasonably short, sharp shock of the early 1990s or will linger on like the sustained downturn of the 1970s.

Things are different too this time in terms of what measures are available and the impact they will likely have. Now, central banks are less able to support the economy. The double whammy of COVID spending and lockdown-driven supply chain chaos, together with the war in Ukraine, has battered global markets.

Remember, even though we suffered massive economic shock during the global financial crisis, in 2007, central banks around the world had new tools at their disposal. UK interest rates were 5.75 per cent, and there was no quantitative easing. The BoE had somewhere to go, and it did.

All the BoE can reasonably do now is raise the base rate and scale back QE. While the hope is this will encourage saving and limit spending, the reality is domestic monetary policy has little power to combat inflation occurring outside national borders. The effect that tightening monetary policy has within the UK, then, is largely to dampen investment and spending.

There are obvious implications for the mortgage market.

Mortgage rates are going up, borrower affordability is going down. It’s likely that criteria will tighten on new lending at a minimum to compensate for the likely rise in the need for forbearance. At the moment, house prices are still rising at rates in the double digits, but there have been murmurings that the housing market is starting to cool, and that next year will see house price inflation drop right back to more historically normal rates.

This puts pressure on credit policy and is likely to rein in credit policy on higher-risk loans.

Such is the uncertainty facing Britain’s economy that the public – guided by hawkish comments from the BoE and International Monetary Fund – believes that we’re heading into years and years of rising housing costs.

This has triggered very atypical behaviour across the market. Although evidence is still anecdotal, there has been a definite rise in the number of homeowners who, locked into their fixed-rate deal for months or even years, are opting to pay the early repayment charge and remortgage to a long-term fixed. Understandable – but it is not the right solution for everyone, and advice here is crucial.

At least one society recently reported that it had seen ERC payments almost double in 12 months, up 88 per cent so far this year. Depending on how long is left on deals, borrowers are paying thousands of pounds to lock into rates they believe are going to be the cheapest available for years to come.

There is a real danger here for intermediaries under pressure from alarmed clients.

Even where there is less than a year left on a deal, one per cent of the outstanding balance could be hundreds or even thousands of pounds more than the savings made by switching to a long-term fix over the duration of that deal.

Add to this the fact that most lenders allow up to 10 per cent overpayment a year, and the savings made in interest payable over the term are likely to exceed those made by locking into a deal.

When you factor mortgage fees into the balance, this could make even less sense financially. Fear is driving some behaviour, but good advisers must be prepared to steady the ship as we ride this coming wave. Following the tide of public opinion and not the numbers poses risks for us all. M I

The latest on BNPL and 50-year mortgages

Shaun Almond

MD, HLPartnership

As the cost of living rises and incomes remain obstinately flat, buy now, pay later (BNPL) schemes present an appealing option for spreading the cost of goods over a period of months and paying no interest for a fixed period. On the face of it, borrowing at no cost and paying off a loan in easy-to-manage chunks seems perfect. The whole principle of using OPM (other people’s money) to fund purchases, particularly at no cost, seems like a dream come true.

The benefits are very clear, provided payments are kept up. It can be hugely beneficial from a cash flow point of view – but the downsides are not so immediately evident to customers, and can become a major problem.

Missed payments can mean the imposition of fees and then having interest charges imposed on any outstanding balance. Some companies may also pass unpaid debts on to debt collection agencies.

As the negative outcomes around BNPL become more apparent, regulators and other agencies are waking up to the fact that this kind of borrowing is largely uncontrolled and are finally reviewing it. Until recently, there was no compulsion for BNPL lenders to share their client data with credit agencies, but that is now changing. For all of us working to provide suitable borrowing options in the mortgage market, BNPL creates another potential hurdle in our quest to help our customers.

If payments are late or missed altogether, or a large number of BNPL deals are registered, a person’s credit score can be affected, especially if debt collection agencies become involved. In turn, this can lead to difficulties in obtaining mortgages or other forms of credit.

BNPL schemes are fine while payments are being made, and a positive case can be made for them because they usually stretch over just a few months, during which no interest is charged. But because the bar for qualification is so low, they are more likely to attract those who are financially vulnerable.

According to a BBC report for Panorama, an estimated 15 million adults of all ages in the UK are actively using this form of credit, an increase of more than two million from the start of the year. Also, research by Equifax suggests about 30 per cent of those are 20-to-30-year-olds.

A sign of the potential trouble with this comes from a Citizens Advice survey of 2,288 people who had used BNPL during the previous 12 months. It found that while 52 per cent made repayments from their current accounts, 23 per cent were using a credit card, nine per cent were using a bank overdraft, and seven per cent were borrowing from friends and family.

While there are reports that tech giant Apple will soon be adding a BNPL facility to its iPhone, pressure is growing on BNPL providers to become more transparent regarding borrowers’ activity, ahead of likely action by the financial regulator to formally regulate the sector. Swedish financial company Klarna, the leading BNPL provider in the UK, started sharing customer data with two credit agencies, Equifax and TransUnion, from 1 June, meaning credit card companies will be able to see transactions and debts when conducting formal checks on potential borrowers for mortgages and other finance.

We would recommend every adviser with customers who have outstanding BNPL arrangements review them, particularly if they are thinking of taking out more credit, remortgaging, or moving house.

50-YEAR MORTGAGES

Many people will pour water on the idea of a 50-year mortgage, and yet, according to the Building Societies Association, 37 per cent of first-time buyers have taken out mortgages of between 30 and 35 years, whilst only 10 per cent have opted for terms of less than 20 years, with the main reason being the growing mismatch between accelerating house prices and slower-to-grow pay packets. So, on first examination, 50-year mortgages don’t seem so much of a stretch.

But the question we should be asking is whether increasing the term to make mortgages more affordable without really tackling the historic inability to meet the demand for new-build property is just another sticking plaster to keep the market moving.

Also, the idea of passing mortgage debt down the generations opens up many more questions, especially around fundamental points such as whether a generation possibly not even born yet would want to accept that responsibility or whether a 50-year mortgage would be portable enough for a lifetime, particularly if a homeowner wanted to downsize.

I can’t wait to see lenders’ analysis of the risk/reward equation. M I

Landlords will be the pioneers of EPC-based lending decisions

Mark Blackwell

COO, CoreLogic

On 30 May the Department for Levelling Up, Housing and Communities approved a new set of methodologies used by energy assessors in a bid to provide a more consistent and fairer approach to how energy performance certificate ratings are set for new buildings.

In six months’ time, the new definitions will also apply to EPC ratings given to existing homes.

Under the new methodology, EPC ratings will favour homes that use more electricity and less gas, with the CO2 emissions calculation cutting the carbon impact of electricity by half while leaving gas where it is.

It may sound like technical minutiae, but it’s a material change designed to push landlords and housing developers into replacing old gas central heating with electric heat pumps by rewarding that move with a higher EPC rating. The updated standards also give assessors a clear definition to use when rating a property’s thermal performance and ventilation, and introduces a measure on how prone to overheating a home is.

It comes after years of complaints that EPC ratings on two properties that are virtually identical can vary widely. Developers and landlords are the two groups most immediately affected by tighter building regulations that will set minimum EPC band C ratings on new builds and for all homes let on new tenancies from 2025.

While the industry’s reception of the changes has been broadly positive, many argue that the certificates remain an imperfect measure of true energy efficiency.

I make no judgement on this view, but would observe that the point of data is to make things measurable. Consistency of data is material if the EPC is to function as a reliable measure of energy efficiency, and we’re moving in a direction that provides greater clarity about what the government considers good energy efficiency to be. The implications for poorer households and landlords unable to meet the cost of renovating homes to meet minimum standards, set to become stricter and stricter over the next decade, will take time to filter through to public awareness.

However, the changes will affect the costs of running a home significantly. Not only will better insulation and ventilation mean higher EPC band-rated households use less energy to heat and cool their homes, but the cost of that energy will also get cheaper.

By contrast, homes heated by gas boilers and with gas ovens and hobs will see their energy bills rise far more quickly, exacerbating the existing energy crisis. There is no doubt that, far from being an erroneous piece of paper that buyers couldn’t give a monkey’s about, the EPC rating is going to become an important factor affecting the desirability and therefore value of a property.

Lenders know this. And there are early signs that it is already directing lending policy. Some lenders have begun to offer buy-to-let borrowers free EPC reviews along with remediation work plans to help them get an early start on costing out mandatory expenses.

Other lenders are offering green mortgages – on both buy-to-let and owner-occupier mortgages – with rates directly linked to the property’s EPC rating. A few adjust the rate down as energy efficiency ratchets up the EPC band rating.

Landlords and lenders have to be able to trust the energy efficiency rating on properties in order to assess and account for the costs of bringing homes up to standard accurately and in a relatively short timeframe. Until now, that uncertainty and lack of trust have meant the cost differential on mortgage finance for energy-efficient properties has been negligible compared to that for homes with poor EPC ratings. It has not spurred meaningful action from a significant proportion of landlords. But this will change, and fast. It looks increasingly likely that lenders will begin taking a much more active role in making the cost of finance contingent on those improvements. There is also a risk that loanto-values will be rerated where remedial works are not carried out by the deadline – perhaps even before that, given the very clear impact that an insufficient EPC rating will have on the value of a property. This is particularly the case for landlords, who will be unable to offer new tenancies without meeting band C or above in just two and a half years’ time.

No tenants, no rent, no income. Some buy-to-lets could be rendered effectively valueless as rental properties until sufficient works are completed.

Until now, net zero has been a reasonably lofty ethical idea that hasn’t merited practical changes in the here and now. That’s about to change – and it will reshape the private rented sector most clearly in the very near future. M I