The second-charge lending market used to be a reserve option, used predominantly by near-prime and sub-prime audiences, but it has been transformed by regulatory reforms, product refinement and tighter underwriting.
As a result, it has grown substantially in the past three years, leading some observers to draw comparisons to the period preceding the financial crisis as customer indebtedness rises.
We believe these comparisons are unfair, and that the market now shows fundamentally different characteristics compared to the pre-credit crunch era.
While it is unlikely to ever reach its pre-crisis size, continued sustainable growth over the medium term is expected, driven by five principal demand and supply-side trends:
• Increased broker awareness.
In recent years, consumer awareness of second-charge mortgages has been low, and second-charge lending distribution has been reliant on intermediary referrals.
Following the Mortgage Credit Directive in March 2016, awareness of second-charge mortgages among first-charge brokers and financial advisors has increased.
This has led to a rise in referrals from first-charge brokers – a trend expected to endure as their awareness continues to grow.
• Decrease in interest rates.
Historically, interest rates for second-charge mortgages were relatively high and less attractive compared to alternatives, such as remortgaging.
The decrease in rates from typically more than 10 per cent in 2015 to about 6 per cent in 2017 as a result of continuing low base rates, increasing rigour in underwriting processes leading to lower default rates and the reopening of securitisation markets supported the growth of second-charge products.
This has made them more attractive, and has also made large loans more affordable and accessible to a wider audience.
Rates in the market have decreased to such an extent that they are beginning to converge with first-charge rates, resulting in many consumers topping up with a second charge rather than remortgaging the entire sum at a potentially higher rate.
• Product innovation.
More products are available compared to the immediate post-crisis market, such as longer loan terms (up to 35 years), higher maximum values and more products at a high loan-to-value ratio (85 per cent plus).
These changes have resulted in a wider range of customer needs being met and more addressable consumers.
• Housing market dynamics.
House prices have continued to rise – for example, increasing by about 6 per cent a year from 2014 to 2017. This growth has reduced outstanding LTVs, leading to an increase in the capital available for release through second-charge mortgages.
Furthermore, as house prices increase, so do demands for home improvement, as rising consumer uncertainty sees homeowners choosing to stay put rather than move.
• Increased indebtedness.
Growth in unsecured credit has resulted in greater demand for debt consolidation. Unsecured consumer credit grew at about 7 per cent a year between 2014-2017, with mortgagors accounting for about 40 per cent of unsecured consumer credit.
This has led to constraints on households’ ability to access further unsecured credit.
As consumer debt increases, so does the demand for debt consolidation and therefore potential need for second-charge mortgages.
The opportunities for lenders, funders and equity investors are substantial, but a ‘shoot from the hip’ approach is unlikely to yield positive results.
Winning strategies will be founded on a sound understanding of the market and consumer behaviour.
Peter Ward is a partner at LEK Consulting
