Opinion on current trends or market issues

Setting prisoners free is the lenders' best option

Katherine Meredith

With standard variable rates on mortgages gradually rising over the last two years, there’s a growing group of mortgage holders who took out their mortgages five or more years ago and are stuck on interest rates in excess of 4.5% and rising. This group is sometimes known as ‘mortgage prisoners’. These mortgage prisoners typically took out mortgages with higher loan-to-values, at a time when lending risk and affordability criteria were less stringent than they are now. Increased regulatory focus on the quality of new lending, in particular affordability; coupled with higher loan-to-value percentages at the point of taking on the mortgage and falling house prices, mean for many people, refinancing options are limited. For these borrowers, this can mean their monthly mortgage payments are rising while household incomes are under pressure with little wage growth and higher costs of living. Inevitably this is giving rise to increased levels of payment arrears and greater volumes in collections with the associated costs and higher provisions. It’s estimated that 15% of mortgage holders are currently in this ’mortgage prisoner’ situation.

The Mortgage Market Review (MMR) and the transitional rules that came in to effect in October last year, required lenders to allow leeway in their lending criteria so that mortgage prisoners are able to move to lower fixed interest rate deals, even if they would normally fall foul of the new rules on affordability. These transitional arrangements are designed to mitigate the impact of the new responsible lending rules on affordability for existing borrowers, providing the decision is deemed to be in the best interests of borrowers and doesn’t involve additional debt. However, this isn’t a new practice in the market - it’s clearly in the interests of lenders to move ‘mortgage prisoners’ off higher standard variable rates, onto more affordable fixed rate monthly repayments. This has been happening quietly for some time. It’s best practice to offer eligible consumers the option to re-finance onto a more affordable option lifting the heavy financial burden that has weighed them down for so long. However, eligibility criteria for re-financing, typically requires that the borrower hasn’t missed any monthly payments. Yet an increasing proportion of mortgage prisoners have done this at some point recently, as their household finances have been put under pressure by rising interest rates - it’s a ‘catch 22’ situation.

Why lenders can benefit

Lenders should take this opportunity to ensure customers are comfortable with their current repayments on standard variable rate loans. Ongoing affordability monitoring and using stress testing to monitor the likely impact of increases in standard variable rates, particularly on the most vulnerable segments of the portfolio, is key to understanding a consumer’s need to re-finance. This kind of approach not only complies with the FCA’s stance on treating customers fairly, but can mitigate future increases in payment arrears and provides a heightened level of customer service which is bound to pay off in the long run. By ensuring customers are able to keep up with repayments and taking on board the FCA’s revised guidance that they should make exceptions for customers who are clearly stuck with an unsuitable mortgage; lenders are showing consideration for ongoing affordability which will reduce overheads in collections, losses from repossessions and capital requirements to cover provisions.

When the current lender can understand which consumers are in difficulty, primarily as a result of the higher mortgage payments and upon re-financing will become a valued customer (who can afford their monthly commitments once again); this should form an integral part of the retention strategy. If lenders aren’t offering alternatives to these ‘mortgage prisoners’ who represent future profitable customers, the market will evolve and provide attractive options for them elsewhere. When a customer opts to refinance though another lender, this could have a knock on effect on profitability outside the mortgage portfolio, because a customer may want to keep all of their financial products with one supplier. That’s why it’s important lenders make a decision based on clear understanding of the future position of these customers - to benefit both the customer and themselves.

Staying in the know is vital

Clearly not all ‘mortgage prisoners’ will be able to afford their monthly commitments if they re-mortgaged, there are many whose levels of borrowing are too great to support even reduced monthly mortgage payments. There are others where there is insufficient equity within the property to underpin refinancing. Understanding who is at risk of being a terminal mortgage prisoner is also vital for lenders, as the regulation is clear that if forbearance (in any form) is not to the long term interests of the consumer and the lender, then it may only be delaying the inevitable. This relies on a deeper understanding of customer affordability and an accurate assessment of the current value of the property.

Giving customers appropriate and informed choices

The ‘mortgage prisoner’ phenomenon is not going to go away any time soon. Standard variable rates are continuing to rise and economic pressures on households are forecast to remain for the next couple of years. Understanding a customer’s position and determining when low levels of affordability or missed payments are purely a result of inability to re-finance in the post-credit crunch world of tighter lending criteria, is vital. It not only meets the regulatory requirements, but allows lenders to convert ‘at risk’ customers into profitable ones and identify those where re-financing would only be partially addressing a wider over-indebted position.

Katherine Meredith
Head of Business Intelligence

Heading the Business Intelligence Group, Katherine has responsibility for the benchmarking consultancy service, Market & Portfolio Insight; With over 20 years of credit risk experience she provides insight into the consumer credit market trends, working with clients to develop their strategy from market opportunities for growth to assessing the impact of lending policy upon loss forecasts.


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