What can be done to help "mortgage prisoners"?
Published: 19 April 2012 | Author: Bernard Clarke
There has been considerable coverage in the media recently about the plight of "mortgage prisoners." Journalists have highlighted the difficulties faced by a minority of borrowers who find themselves unable to remortgage to a new home loan.
In its response to the mortgage market review, the Financial Services Consumer Panel (FSCP) said it was concerned about the Financial Services Authority’s (FSA) proposed transitional arrangements for borrowers who find it difficult to remortgage because of changing market conditions. The FSCP defined these mortgage prisoners as "consumers who have historic mortgages that may now be outside the responsible lending criteria."
A number of commentators have argued that consumers may be disadvantaged because their choices may be restricted, either because they do not have enough equity in their homes to meet tighter lending criteria or because they are affected by proposals that will make it more difficult to take out an interest-only mortgage.
We are also concerned about existing borrowers whose refinancing options are limited, although the standard variable rate (SVR) they are likely to end up paying as a result is a good option for many.
In the last issue of this newsletter, we looked at the issues raised by the FSA’s proposals for interest-only borrowing. In this article, we turn our attention to those borrowers who may find it difficult to remortgage because they do not have enough equity in their home or do not meet responsible lending criteria for other reasons.
The FSA is aware that a potential consequence of introducing new rules for mortgage lending is that there may be restricted choices for existing borrowers looking to remortgage. It is therefore proposing transitional arrangements to help this group of customers. It suggests that new rules on affordability need not apply to existing borrowers looking to remortgage as long as they meet strict criteria, including requirements that:
- there is no additional borrowing;
- the borrower is not allowed to take on higher monthly payments; and
- there is no lengthening of the term of the mortgage.
Over and above these restrictions, the FSA is proposing that the transitional arrangements should not:
- apply to customers who have been in arrears or had a payment shortfall;
- permit the removal of existing borrowers to the mortgage agreement or the addition of new ones; and
- be considered in cases where the size of the loan has already been increased (other than to cover arrangement or other mortgage product fees, or to carry out essential repairs and maintenance of the property).
It is unlikely that many firms will be able to use the transitional arrangements, as proposed, to offer loans to customers seeking to remortgage away from an existing lender: the restrictions on lending new money, altering the term of the mortgage or the repayment method, or making other contractual changes are too onerous. The new lender is not only prevented from changing many of the key features of the loan, but must also ensure it complies with rules to keep additional records on any business it accepts under the proposed transitional arrangements.
But although lenders are unlikely to take on new borrowers under the proposed rules, they may have other options to help existing customers. In many cases, lenders may be able to respond to their needs by agreeing to vary their current mortgage contract. With the borrower’s agreement, it may be possible to make changes to the mortgage term, the method of repayment and other loan features, as long as such changes do not create a new contract.
Our option for mortgage "prisoners"
A major concern for lenders about the current proposals is that they do not give firms enough flexibility to help borrowers. This is likely to result in a more limited range of options for a group of consumers whose choices are already restricted because of changing market conditions.
We believe that more borrowers can be helped if the FSA were to consider a different approach, namely to allow exceptions to its policy on responsible lending for mortgage prisoners as long as the mortgage still complies with the rules. This would enable lenders to help customers in exceptional circumstances, and allow borrowers to increase their lending or monthly repayments where it is demonstrably in their interests to do so.
The standard variable rate option
If a borrower is unable to remortgage because his or her circumstances do not fit current lending criteria, the lender will, in almost all cases, agree that the customer should switch to its standard variable rate (SVR). (One of the consequences of this is that borrowers who had been paying a fixed rate would have less certainty about the size of their future mortgage commitments.)
It is true that, in recent years, many borrowers who could have remortgaged to other deals have voluntarily opted to revert to the SVR because this has been the cheapest option. It may not stay that way, however: in the last few months, some lenders have raised their SVRs in response to higher funding costs. But SVRs remain low by historical standards and are still the preferred choice of many borrowers.
In its response to the FSA’s mortgage market review, the Financial Services Consumer Panel (FSCP) said it was concerned that mortgage prisoners could "find themselves paying significantly higher interest rates with no options to move elsewhere." The FSCP has suggested a specific rule to ensure that consumers "are not unfairly treated or discriminated against by reason of their inability to access alternative, more competitive mortgage products."
There is little evidence so far, however, that borrowers on the SVR – whether through choice of because they are mortgage prisoners – are paying uncompetitive rates.
Lenders’ SVRs in the fourth quarter of last year were the lowest they had ever been, according to the FSA, and have been slower to rise than the regulator expected. And although some rates have edged upwards since then, this has been in response to higher funding costs.
Addressing the Treasury select committee in March, Lord Turner said: "We were a little bit surprised in the autumn that they did not go up a bit earlier. Because of the euro zone partly, there were pressures on the wholesale funding market that were reflected in the cost of wholesale funds, and we thought it likely that at some stage they would be reflected in an increase in mortgage rates."
Keeping SVRs in check
An important consideration for any lender considering increasing its SVR is that the rate applies to many borrowers, not just those who are mortgage prisoners.
Lenders who re-price their SVR upwards too aggressively in response to higher funding costs therefore risk incentivising some of their best and most creditworthy customers to remortgage to other firms. Higher rates also trigger payment difficulties, so prudential concerns – as well as market pressures – help to keep in check any moves by firms to raise their SVR.
Over and above the competitive pressures on lenders to maintain low SVRs where they can, there are specific checks on the capacity of lenders to revise their rates:
- Under existing mortgage conduct of business rules overseen by the FSA, lenders are required to give borrowers a month’s notice of any increase in rates.
- A lender’s SVR is also subject to the terms and conditions of the mortgage, and to regulations governing unfair terms in consumer contracts. In the past, the FSA has taken action against a number of firms to stop what it has seen the use of unfair terms. and to compensate borrowers affected.
We support the FSA’s desire to help borrowers who, through no fault of their own, cannot take out a new mortgage. We also agree with the FSA that fairness should be the key requirement in devising measures to help vulnerable borrowers. Another crucial requirement is that such measures should enable firms to lend, but not compel them to do so.
The main concerns for lenders considering loans for new customers under the proposed transitional arrangements is that the rules are too onerous and do not allow enough flexibility to help borrowers. Lenders are also concerned that they will be accepting new business that may not comply with new regulatory standards. Although this would be allowed under the new rules, many firms are likely to consider this option to be too risky.
We therefore favour an approach that would give lenders greater flexibility to help borrowers who want to remortgage. It would be better, for example, to allow borrowers to increase their lending or monthly repayments where it is clearly in their interests to do so.
As an alternative to remortgaging, many mortgage prisoners revert to paying their existing lender’s SVR. There is, however, little evidence that they are disadvantaged by doing so – and many other borrowers who are free to make other choices prefer to pay the SVR because it is an attractive option.