These positive signs are not a reflection of a new, normal competitive market returning in the short term. Therefore we should not be complacent that we are out of the woods. Indeed recent comments by Sir Mervyn King, the former governor of the Bank of England, are a timely reminder that many existing borrowers need to plan ahead for a world of higher interest rates.
Both forms of institutional support will continue in the next few years, and some borrowers will undoubtedly benefit in the short term by accessing the market for the first time or being able to move home. But the industry recognises the need for a clear exit strategy from taxpayer and central bank support. Lenders need to make decisions based on the assessment of risk of borrowers rather than simply relying on government schemes when offering mortgages.
A recent report by the Royal Institution of Chartered Surveyors, Housing Commission – More Good Homes and a Better UK, highlights how the absence of cross-party political support has undermined housing market efficiency for many years. Its primary recommendation was the need to end short-term and partial policies for housing. And yet, as the Help to Buy scheme coincides with the run-up to a general election, some will argue that this is a populist short-term policy rather than a long-term strategy.
Nevertheless, as a result of institutional support, we are now likely to have increased net lending in 2013 and more of the same in 2014. It was, therefore, interesting timing for both Sir Mervyn and the Financial Policy Committee to warn last month about the risks and consequences of future interest rate rises. Particularly as I doubt that the new Bank governor, Mark Carney, will want to mark his arrival by raising rates any time soon.
The first recommendation of the FPC, reported in the latest Financial Stability Report, was that the FCA and the PRA, with other Bank staff, should provide an assessment to the FPC of the vulnerability of borrowers to sharp upward movements in long-term interest rates in the current low interest rate environment. The regulators have been asked to complete the work in just three months and to report back to the FPC in September 2013.
So a wide ranging review of the likely impact, and with a quick return date showing the FPC’s view of the urgency of the issue. What will the review find? From a systemic point of view I think it will reaffirm that forbearance policies and reporting standards vary between lenders, and that some businesses have significant numbers of borrowers who would be stretched if rates go up.
For example, the Financial Stability Report quotes a stark consumer research finding that 18 per cent of secured loans were held by households with less than £200 of income remaining a month after housing costs and essential expenditure. And we also know from past research by the FSA that 5 per cent to 8 per cent of borrowers benefited from some form of forbearance in 2012. The signs of financial stress are obvious, even if they are not yet reflected in worsening mortgage arrears and repossession figures.
From a conduct risk perspective, the FCA already has lenders’ practices under scrutiny as it announced a thematic review of arrears and possession processes as part of its risk outlook this year. With interest rate rises, I would anticipate significant financial pressure for many households who have got used to low housing costs. And the potential for a hike in complaints due to poor administration, or unfair charging practices, would follow. This is already a modest feature of the Financial Ombudsman Service’s regular work, even with arrears levels low and most borrowers managing their mortgage payments well.
Overall the risks for existing borrowers, particularly lower-income borrowers, are real and will grow if interest rates rise by only a small amount. It will be difficult for the FPC to address these issues even if the risks are fully identified, and so it will be an ongoing factor that will influence the timing and speed of interest rate rises in the future.
The Financial Stability Report quotes a figure of 9 per cent of borrowers (and that is more than 1m households with loans) who would have to take new action to afford their loans. The action could either be increasing their working hours to enhance their income (if they can), remortgaging (if they are not a mortgage prisoner), cutting other essential expenditure, or perhaps extending their loan term.
These will be difficult choices for many, and a lender’s ability to offer help will be constrained by the PRA’s attitude to future forbearance and provisioning against possible losses, which is likely to be tighter in an environment with more risk of losses. To date, mortgage write-offs have been substantially below levels seen in the recession of the 1990s but this could quickly reverse when interest rates rise.
When rates go up, it will need careful handling by the authorities and lenders together to avoid unintended consequences creating a downward spiral in the market, house price falls in areas of concentrated risk and forced sales.
What can be done now to minimise these long-term risks? Where borrowers can afford it, they should continue to pay down their loans and reduce their exposure. For higher-income borrowers, this has been a feature of recent years, and overall averages show the UK household debt to income ratio has fallen since the credit crunch began. However this is not reassuring in itself as many marginal borrowers have been unable to make inroads into their debt levels, even with base rates at 0.5 per cent. And many of these same borrowers are on interest-only mortgages and would not be able to afford a switch to a repayment mortgage when rates rise.
This uneven distribution of the impact on different borrowers depending on their income status was demonstrated in research by the Resolution Foundation in December 2012 in its report On Borrowed Time: Will Household Debt Undermine Economic Recovery? Its follow-up research work published on 11 July was titled Closer to the Edge.
While rates are likely to remain stable in the near term, lenders can continue to help borrowers who are most in need. But the staff and other resources needed to provide this sympathetic approach to borrowers in need will rise considerably as rates rise. With the FCA’s interest to ensure good consumer outcomes in every case, and the PRA’s concern to avoid systemic risk by the under-reporting of potential losses by lenders, the FPC findings will provide a crucial overview of the extent of the precipice that the industry faces (and will have to manage) in the future.
Michael Coogan is ambassador and strategic adviser to Deloitte, chairman of Shaping Tomorrow, and past director general of the Council of Mortgage Lenders.
Key points
There have been positive signs of momentum in the mortgage market in recent months.
18 per cent of secured loans were held by households with less than £200 of income remaining a month after housing costs and essential expenditure.
While rates are likely to remain stable in the near term, lenders can continue to help borrowers who are most in need.
