The world of lending to individuals is not what it used to be. Once a key element in creating growth, it now faces a battle on various levels from three different stakeholders – the regulators, struggling borrowers and the media. The common theme is affordability.
The challenge from regulators is for lenders to do much more than simply accept that a certain product is what the customer wanted and basic checks showed that they would probably be able to pay it back. Lenders must understand the financial positions of both their new and existing customers, and make proper assessments as to whether a product is right for them.
It doesn’t stop there. Once they’ve sold this product, lenders also need to ensure it remains applicable to the consumer throughout its lifetime.
The whole industry is well aware that mortgage rates are likely to rise in the next year, so the challenge from the point of view of struggling borrowers is understanding and planning for the dramatic impact this is likely to have on them.
Our own research found that homebuyers have their sights set on a property worth an average of £235,000. With a combined household income of £50,674, the average homebuyers claim they can afford an average mortgage payment of £780 a month. However, based on a 10 per cent deposit, repayments on a £235,000 property would actually be nearer to £1,300 a month, and potentially more, depending on their credit history and the lender’s policy rules.
Add to this the fact that the average household income would need to cover around £371 in monthly discretionary spending for such things as socialising, as well as mandatory living costs of £603 for food, shopping, and heating. There will also be average payments of around £602 to cover any savings, pension contributions and insurance. Then there are other credit obligations of around £248 a month.
The average household is likely to be left with something in the region of £760 at the end of each month. An interest rise means even less available cash at the end of the month. Mortgage payments could rise to almost double what the average homebuyer claims they can afford, should variable rates convert to 5.5% at the end of a typical two-year fixed deal – a 1.5 point rise on current rates.
Interest-rate rises are not the only areas that lenders need to be aware of: cost of living increases, pay freezes and reduced benefits are all taking their toll on consumers.
Options are available
From our point of view, the best consumer affordability assessments will mean having real-time access to several metrics:
- Income estimation – a monetary value of income for individuals with multiple, sole, and joint accounts.
- Income verification – a prediction of the accuracy of income data supplied by the applicant.
- Disposable income – a disposable income calculation to understand the ‘ability to pay’.
- Consumer indebtedness – a predication of the risk of various levels of indebtedness.
There are also some key factors for lenders to consider, so that they achieve success in compliance for their affordability assessments:
- Data strategy – review the internal data being used in the consumer affordability assessment process and balance it data from other available sources.
- Algorithm design – ensure that indebtedness and affordability algorithms are well designed and clearly documented. Consider how income and disposable income are estimated and what tolerances are in the algorithms. Ensure they can be amended in your systems.
- Policy design – overall decisions should be based on risk, indebtedness, and current and future affordability. The rigour of the assessment should be consistent with the credit exposure and the policy well documented.
- Process – indebtedness and affordability assessment should be carried out throughout the customer lifecycle – origination, customer management, pre-delinquency, collections and debt recovery.
- Monitoring – monitor the performance of your affordability assessment and update accordingly.
It is apparent that lenders – in both the short term and wider consumer lending sector – will need to have all the right systems and practices in place to instantly make the best affordability decisions and to document thoroughly that these decisions have been made properly. There are some big strides forward that the industry will need to take terms of consumer affordability assessments.