High-risk mortgage lending can lead to a host of problems in an economy. If consumers take on more debt than they can realistically hope to pay off, it can result in risking default or bankruptcy. The lender must then determine how to regain the lost capital before its gearing levels become too high.
Lenders becoming overleveraged and borrowers taking on too much debt were leading factors behind the 2008 global financial crisis. Regulators, adamant that this irresponsibility should not happen again, set out new rules to cut the problem off at its source.
The FCA stated that the regulatory framework in place during the lead up to the crisis had proved not to be robust enough to contain high risk lending and borrowing before it got out of control. A discussion paper on the matter came about in 2009 and culminated in a policy statement and final rules in October 2012. The Mortgage Market Review (MMR) came into effect on 26 April 2014.
For lenders, the changes in MMR mean that they are now fully responsible for assessing whether or not clients can afford the mortgage and verifying their income. For intermediaries, the requirement to assess affordability was removed. Every mortgage provider must have achieved a relevant mortgage qualification, and while most interactive mortgage sales need to be advised, an execution-only route is available for non-interactive sales.
When a client wants to apply for a mortgage, advisers must help them prove to the lender that they can make the payments, even if interest rates were to increase. This applies to new mortgages, increasing payments on a current mortgage, or remortgaging. Proof of employment and income from an employer also need to be presented, or business plans, accounts, and tax returns if the client is self-employed.
Richard Sexton director of e.surv chartered surveyors, says, “The MMR has certainly safeguarded the mortgage market, providing clear markers which will limit the risk of lending to borrowers with smaller deposits going forward. One of the strengths of the new system is the stringent affordability checks it enforces, which work to stress test borrowers’ finances against future potential obstacles, like interest rate rises.”
Confirming spending is where it gets tricky. Funds that the client would need to keep up their standard of living are split into three categories – essential expenses, basic quality of living costs, and repayments and other commitments.
Essential expenses are those that cannot be subtracted, such as food, household items, council tax, building insurance, water, heating, and gas bills. Basic quality of living costs are those that are spent on essentials of varying quality, like clothes, personal items, and leisure. Any unpaid debts, child maintenance or any maintenance orders fall into repayments.
Critics of the MMR have found the required spending details to be too intrusive. Some may feel uncomfortable providing that much detail about their personal spending habits to a stranger, arguing that reporting a lump sum expenditure is enough rather than giving details of exactly where their money is going.
Critics of the MMR have found the required spending details to be too intrusiveRisky business
Though one year may still be a bit early to gauge the systemic impact MMR has had, it appears to be progressing in the right direction.
Andy Knee, chief executive of Legal Marketing Services (LMS), says, “Given the stringent checks in place, the MMR has played its part in limiting risky lending but it is imperative that this does not come at the detriment of the housing market. While we encourage prudent lending, it is important for lender appetite not to be diminished and that people are actively encouraged to enter the property market to aid stable growth in the coming months.”
Lenders in general appear to have adjusted well to the new regulation’s – according to annual figures from LMS, total lending was up by 14 per cent in 2014 and lending to first-time buyers was at its highest in seven years, aided in part by the Help to Buy scheme. However, despite an annual rise in total lending, the MMR also played its part in the cooling of the housing market.
Mr Knee continues, “The introduction of the MMR saw many lenders choosing to err on the side of caution and they did not end up applying the transitional rules as leniently as the FCA expected, causing delays and a tougher time in qualifying for a mortgage to many hopeful buyers.”
Chart 1 compares gross versus net mortgage lending from January 1996 to January 2015 based on data from the Bank of England. Both gross and net mortgage lending peaked near the end of 2007, just before taking a steep downturn during the peak of the financial crisis. Mortgage lending numbers are slowly creeping back up, but not to the point that they were prior to the crash.
Low inflation and six years of 0.5 per cent interest rates have provided borrowers with a false sense of security. Lenders need to enforce stress testing to prevent excessive household debt, and borrowers should seek financial advice to determine how much they can afford.
EU MCD
The European Union has also taken action to prevent excessive mortgage lending with the implementation of the EU Mortgage Credit Directive (MCD). Regulations under the MCD include an affordability test of the customers’ income and expenditures, minimum standards where advice is provided to consumers, consumers’ right to exit the mortgage before the end of the term, fair advertising, and appropriate lending staff training. Treaty obligations with the EU require the UK to adhere to the changes set out in the MCD by 21 March 2016 and will require legislation changes.
The FCA stated in a consultation paper that the UK government does not believe that the MCD offers many benefits to UK consumers beyond those already provided by the MMR, but the MCD does add a costs to UK industry. The government’s proposed approach with both the negotiations and implementation of the MCD is to align the directive requirements with existing UK rules as much as possible in order to minimise the impact on the UK market.
Room to improve
While the FCA would like the majority of mortgage sales to be advised, the MMR could see more consumers turn to the execution-only route. Complaints data shows it has become more difficult to get an appointment with a mortgage adviser, as sessions have lengthened in order to meet the affordability requirements.
Henry Woodcock, principle mortgage consultant at IRESS, says, “Lenders have definitely upped their game and virtual advisers using remote sessions via systems similar to Skype are helping. As the remortgage market grows, savvy borrowers will want a ‘self-service execution-only’ route when buying a mortgage. They will look to engage across multiple devices such as smart phones and tablets, just like they do across other aspects of their life. Lenders will need to respond to this by developing robust and efficient online propositions for this digital generation of customers.”
One of the greatest challenges faced by the UK housing market that has yet to be addressed is lack of supply. If more houses are not being built, then prices will continue to rise, making it increasingly difficult for first-time buyers or those with smaller deposits to find an affordable option, especially as loan-to-value (LTV) lending criteria tightens.
Table 1 shows the change in lending and affordability for first-time buyers over the past year. From January 2014 to 2015, the number of loans to first-time buyers fell by 14 per cent and the value of the loans fell by 9.6 per cent. The average LTV remained consistent, while the proportion of income spent on interest payments fell slightly, as did the proportion of income spent on capital and interest payments.
Mr Sexton says, “Lending to borrowers with smaller deposits took a dip following the MMR’s introduction, but this slowdown has passed, with higher LTV lending reviving recently. Even with this rebound, total higher LTV lending is nowhere near 2007 levels, when smaller deposit borrowers made up about a third of total lending.
“With house prices still rising and building a deposit being one of the biggest obstacles to getting on the housing ladder, higher LTV lending has a huge part to play in the revival of the mortgage market. The MMR should ensure it does so in a safe way.”
While the MMR has made headway in limiting risk-taking in mortgage lending since its inception a year ago, opportunities remain to build on the progress in making the UK’s housing market more secure.
