The Evolution of the Mortgage Market

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Speech by Linda Woodall, director of mortgage and consumer lending, Mortgage Finance Gazette Conference: Evolution of the Mortgage Market, London. This is the text of the speech as drafted, which may differ from the delivered version.

Our data does not necessarily support the view that older borrowers cannot get a mortgage or remortgage. The proportion of loans advanced that extend beyond the age of 65 continues to steadily increase.

Good morning everyone and thank you to the Mortgage Finance Gazette for inviting me along to its first mortgage conference.  I quickly googled ‘Evolution’ and found it defined as ‘the gradual development of something’ and I think this is very relevant to today’s mortgage market. I also think that in 2009 when we started to consider what types of reforms were needed to create a sustainable mortgage market that would work better for everyone, our proposals were seen as revolutionary. However, after several consultations and some fine tuning I think that by the time the new rules went live in April last year, the mortgage market had evolved in such a way that the new rules largely hardwired what was already good practice in most firms.

And so today I will:

  • Make a few observations on what life looks like almost one year on from the MMR and some of the challenges still facing the industry.
  • Talk about our new Project Innovate initiative and innovation more generally.
  • Highlight the major changes as a result of the Mortgage Credit Directive – particularly in respect of Second charges and Consumer Buy to Let.

So, one year on and despite some scary headlines, it has been in the main business as usual for the mortgage market, mainly because the market had largely self–corrected. Credit-worthy consumers have still managed to get mortgages and lending continues to recover slowly from the post crisis slump. And the advised sales process may be taking a little longer than is necessary but we are encouraged that things are moving in the right direction. I am also aware that lenders are looking to develop their digital mortgage sales platforms in order to make them more user friendly to provide consumers with an execution-only mortgage channel.

I am not sure what the latest predictions are for online mortgages but despite the amazing growth of technology in our everyday lives, online mortgage growth remains small.  So while it makes sense to be able to provide consumers with this option it is important that firms manage this development carefully and have processes in place to ensure that they do not inadvertently give regulated advice.

I make no apologies or the fact that consumers are now having to spend more time thinking about their income and expenditure when applying for a mortgage because this has to be a good thing and should help them to better manage any unexpected changes in their finances in the future.

And, as we always knew would be the case, there are certain groups of consumers who have been impacted more by the responsible lending rules than others - such as those seeking interest-only mortgages, the self-employed, those who previously needed to self-certify their incomes, and those with a poor credit record. Although interestingly, our data shows a downward trend in lending to all of these consumer groups since 2008 highlighting the fact that lenders risk appetites substantially tightened well in advance of the MMR.

For example, interest-only lending has dramatically reduced from 32% in 2007 to around 6% currently. Our rules do not ban interest only or set maximum LTV limits or minimum loan sizes – these are all credit risk decisions taken by the lenders. We have always said that interest-only lending can be a perfectly sensible option for some consumers – but that using interest-only to stretch affordability and hoping that things will turn out okay is not acceptable. So we require lenders to check that consumers have a credible repayment strategy in accordance with their interest-only policy.

But we recognised that there would be a number of perfectly credit-worthy existing mortgage borrowers who would also not be able to pass the new affordability tests. And lenders told us that they wanted the flexibility to be able to help these borrowers and to minimise the impact of the new rules. So it is disappointing to hear from various sources that some lenders are not helping their existing borrowers, by applying affordability tests which are not required by our rules, therefore preventing these existing borrowers from moving to a new deal with them.

I am aware that I have made this point in other speeches but I make no apologies for repeating myself because this is a serious issue particularly in view of a rise in interest rates which will eventually happen. Low mortgage rates have provided a number of borrowers with breathing space and although we are unlikely to see rates move up very quickly, many borrowers will find any increase difficult to manage. It is important that credit worthy borrowers who are unable to remortgage are given the opportunity to protect themselves from rates rises by their existing lenders and so I would urge all firms to look more closely at their interpretation of the rules to see whether this is really delivering the right outcomes for consumers.

The changes made by the MMR were the beginning of the evolution of the mortgage market. But regulation is only one part of the story – the other part is the need for change and innovation to cater for a very different mortgage market than the one that existed prior to 2007.

Regulators and firms around the world are waking up to the very real challenge created by an ageing population. It’s great news that we are all living longer but that also presents huge challenges not only for the National Health Service but also financial services and in particular the pensions industry. If we are living longer, our pensions will need to last longer and we know from various studies that in the UK we have a serious pension’s gap. In a Government study in 2013, it was revealed that up to 13m people could be heading for a drop in living standards when they retire and we know that an increased number of consumers will not be in a position to repay their mortgages before they retire.

Ageing population

This a very ‘live’ issue with concerns raised that older borrowers are finding it more difficult to get a mortgage, and that this is partly down to our rules. Our rules do not aim to discourage lending to older consumers. Affordability is the key, whatever the age of the borrower.

Interestingly however our data does not necessarily support the view that older borrowers cannot get a mortgage or remortgage. The proportion of loans advanced that extend beyond the age of 65 continues to steadily increase (particularly for 65-70 cohorts). But we recognise that there are likely to be difficulties where customers need to extend their mortgages beyond the age of 75 for a number of reasons.

Firstly, while pension income is very stable, many consumers are likely to have a reduced income following retirement, and may not be able to afford to repay their mortgages – as a result of declining pensions savings/larger outstanding mortgages and increased levels of debt.

Secondly, concerns remain about the ability to lend responsibly beyond a certain age because of additional unknown expenditure such as care costs or affordability issues if one borrower dies.

Our affordability rules recognise that lenders can’t predict exactly what a consumer’s future pension income might look like, or even whether the consumer will continue to make pension provision. Where consumers have not yet retired, we expect lenders to consider whether they are likely to be able to afford the mortgage if it extends into their retirement, based on what the lender knows when they are assessing the application. But we recognise this is not an exact science. It is not possible predict what a borrower will do tomorrow. A proportionate and common sense approach is all we expect. Beyond that, it is for the lender to set their own criteria.  

But we have to acknowledge that mortgages were originally designed to help consumers to buy their homes and to be repaid on or before retirement. This was the norm for decades. However, given changing demographics, is the traditional mortgage the right product or do new products need to be designed to bridge the gap between a traditional mortgage and a Lifetime Mortgage? While Lifetime Mortgages provide a useful source of funding for consumers who already own their properties or have a very low loan to value and need to release equity there are very few mortgage products that cater for older borrowers with larger mortgages that extend well into retirement.

We are seeing some product innovation in this space and we will be keeping a close eye on this, working with the industry to see whether new developments deliver the right consumer outcomes. 

Project Innovate

And innovation is something we are keen to support with our Project Innovate initiative which aims to support industry innovation: from smaller start-ups to mass market developments with new models.

In launching Project Innovate we considered the following questions:

  • First, how do we encourage innovation in the financial service market?
  • Second, do we currently do enough to promote competition and create room for new entrants into the market, particularly those with novel business models?
  • And, third, does FCA regulation more broadly serve the needs of innovative businesses?

It is very important for regulators to be ready for a world that is continually being re-shaped by technology and to be standing on the right side of progress.  A key objective of this project is to make sure positive developments, by which I mean the ones that genuinely promise to improve the lives of consumers are supported by the regulatory environment.

In other words, we want an FCA that creates room for the brightest and most innovative companies to enter the sector.

So, priority areas here might include the likes of mobile banking, online investment or money transfer, where we’re seeing innovations such as apps that allow you to take a picture of a bill and make payments with a tap of the smartphone. The possibilities opening up for consumers are extraordinary and it’s clearly important they can be developed in the UK.

But what could this look like for mortgages?  Will the future see apps being developed to allow consumers to apply for mortgages on their smartphones and if so how will consumers be able to absorb all of the information they need from a small screen?

To help this happen, the FCA has opened its doors to financial service firms (large and small) looking to develop innovative approaches that aren’t explicitly addressed by current regulation – or where the guidance may be ambivalent. We are looking to support innovators in two distinct ways.

  • Firstly, by providing help and compliance advice to firms who are developing new models or products so they can navigate the regulatory system.
  • Secondly by looking for areas where the regulatory system may need to be adapted for new technology or broader change – rather than the other way round.

Niche lending and the need for good governance

Unlike some financial services sectors, the mortgage market is known for its innovation. This can be seen in the range of products designed to meet specific consumer needs over the year such as Shared Ownership loans, Self- build products, Offset and Flexible mortgages and Lifetime and Reversion products for the elderly.

I have heard it said that the MMR has indirectly created a number of ‘Niche’ markets, in so far as some lenders have now chosen not to play in certain market segments such as lending to the self-employed or contractors who have only been trading for a year, lending into retirement, and interest only mortgages. While our rules do not prevent lending to any of these groups of consumers, lenders are entitled to set their own risk appetites and some have decided to focus on mainstream lending only.  

Some lenders will see these niches as growth opportunity in what is currently a highly competitive and crowded market. So it is important that when considering how to increase lending and targeting new areas firms have the appropriate product governance structures in place to identify and mitigate any additional risks.

We know from past experience that governance over new lending strategies has sometimes been lacking. So for example, in the past one way of targeting niche areas was to compete for business by relaxing lending standards.  We saw firms offering 100% plus mortgages, or offering mortgages for over indebted consumers or those with insufficient incomes. While I am sure there was a demand for these products, the question is whether the firms had sufficient controls in place to fully assess the underlying risks both to the consumer and the firm and also whether distribution strategies were managed and reviewed to deliver the right outcomes.

To help firms when thinking about developing new products and distribution strategies we have recently undertaken a thematic review which looks at firms Governance of Mortgage Lending Strategies and we will be publishing the report on 19 March. 

And more change is on the way as a result of the Mortgage Credit Directive. Most of the changes were anticipated and reflected in the MMR such as the strengthening of the rules on responsible lending, and arrears management but there are still a number of changes for the industry, not least the changes required to disclosure documents, and the introduction of a refection period.

Second charges

But perhaps the biggest change is the fact that from March 21 2016 second charges will be regulated under our mortgage rules, rather than our consumer credit rules.

We know that the second charge market is important for consumers who wish to borrow additional money and have equity in their home. And we know there are differences from the first charge market. So it is important to get the balance right in terms of a regulatory approach that allows the market to function effectively, while offering consumers adequate protection from the risks associated with taking out a secured loan which evidence shows are greater in the second charge market.

We also know that a far higher proportion of customers in the second charge market take out a loan for debt consolidation purposes.

Consolidating debts via a secured loan can be the right solution for some consumers as long as it is affordable. But consumers struggling to cope with debt may feel pressured to find a solution and enter into an agreement that prolongs and could even worsen their financial position rather than seeking help with their debts. This is a concern and is evidenced by the higher arrears rates of around 20% of all loans, a similar magnitude to the ‘poor tail’ of first charge lending that we sought to address through the MMR.

To address these risks, we believe that the key protections of our mortgage regime should be applied to the second charge market. So, where a customer wants to take out a second charge mortgage, the product meets their needs and circumstances and is demonstrably affordable. And where a customer does fall into payment difficulties, they are treated fairly.

Just as we have done in the first charge market, we have proposed that second charge lenders’ affordability assessments should take into account a customer’s verified income, credit commitments and basic quality of living costs. Both now and in the event of known changes in circumstances or an expected increase in interest rates.

Of course, affordability is only one aspect of getting a second charge mortgage. It is also important that a consumer gets a loan that meets their needs, where they understand the risks - and where they are not persuaded to borrow more than they need, which is why we are proposing to apply our advice rules. This will mean that consumers will receive advice, from sellers that are appropriately qualified, as we propose applying our Mortgage Conduct of Business sales standards to the second charge market – including and applying the need for the Level 3 qualification.

The final policy statement should be issued at towards the end of March and there will be a dedicated Mortgage Credit Directive web page to help second charge firms to prepare for regulation and to understand what changes need to be made to their business models.  I would encourage firms to check the website regularly so they are fully prepared to submit an application for regulated mortgage business once we are open to accept applications.

Consumer Buy to Let

It is important for this market to move forward – it has been a tough time for all concerned – consumers, lenders and intermediaries but when moving forward we need to guard against a return of the poor practices seen in the past.

I know that there has been much interest in the proposal for the FCA to regulate Consumer Buy to Let. I am also aware that some firms see this as the pre-cursor for the entire BTL market to be regulated.

I think it’s important to recognise this was a decision made by the Government and not the FCA. It’s also important to understand that the government has drawn the scope of Consumer Buy to Let to meet the minimum requirements to satisfy the Mortgage Credit Directive.

That said, Government still believe that the proposed approach will capture around 11% of all BTL mortgages which, on current volumes, would equate to around 18,000 BTL mortgages per year.

So who is a BTL ‘consumer’ you may ask yourselves? While the legislation does not prescribe when a BTL customer is acting as a consumer, it does set out a series of circumstances that would be outside of the scope of regulation such as:

  • Where the customer is using the mortgage to purchase the property with the intention of letting it out.
  • Where the property had been previously purchased with the intention of letting it out and the consumer has not lived in it nor let it to a relative.
  • Where the customer already owns another property that is being let out.

However, for the 11% of consumers who meet the definition, government’s legislation provides that, from March 2016, these borrowers will be able to refer complaints relating to Consumer BTL to FOS.

Although we do not have powers to alter the conduct standards set out in legislation, we are currently consulting on some changes to our Handbook to register, supervise – and where necessary – take action against Consumer BTL firms.  That consultation closes on 19 March. 

We are currently considering our supervisory approach, but in the main expect to apply our standard risk based approach. We have consulted on some high-level, aggregate reporting requirements and will use the data to help us to identify any supervisory concerns at an early stage.

It is important for this market to move forward – it has been a tough time for all concerned – consumers, lenders and intermediaries but when moving forward we need to guard against a return of the poor practices seen in the past.

Einstein said ‘We cannot solve our problems with the same thinking we used when we created them’. The changes to the mortgage market since the financial crisis, the new regulatory approach, changing demographics and the ever increasing pace of new technology requires a fresh approach. A sustainable mortgage market and more robust affordability requirements mean that past innovations where mortgages were extended to those who had previously been excluded from homeownership because of lack of income and/or poor credit will no longer be possible.  But there are other areas of the market such as the increase in the number of consumers who will need mortgages that extend into retirement where a different approach may be needed.

The market today still feels fragile compared to the market pre crisis and that is understandable. The MMR has helped to provide stable foundations to help the market to grow stronger and in a more sustainable way but it is important that any evolution and innovation does not undermine this and continues to have the consumer’s best interests in mind.