UK Mortgage Market Update - May 2008
There has been a lot going on in the mortgage market over the lastfew weeks and much media coverage about the effects of the “creditcrunch”. As mortgage advisers we thought this may help answer a numberof questions.
What is going on?
The UK mortgage market is currently operating in a way in which ithas not done within the last 30 years; certainly very differently fromrecent years.
Last year there was a position of oversupply, with intensecompetition among both new and traditional lenders on criteria andprice. Now we have moved to a state of undersupply, reduced criteriaand widening lender margins, all of which leads to a higher price forthe consumer.
Many lenders have left the market. Others have withdrawn newlending. Even those with strong balance sheets funded by deposits arerestraining their new lending, so as not to damage their operations orover-run their funding budgets.
This has caused a shortage of products; schemes being withdrawn atvery short notice; products being re-priced upwards and criteria beingadjusted.
Why is this happening?
There are three main reasons:
1. A lack of liquidity in the money markets – i.e. the money thatwas previously available for banks to lend to one another. In the pastbanks used their deposits from savings accounts to fund mortgages. Morerecently, mortgage lending has been increasingly funded by the moneymarkets (borrowing from other lending institutions) or from the sale ofmortgage backed securities packages.
Due to very poor arrears experience of the loan within thesepackages, which had been used to fund the American sub-prime market,banks have had to write off huge losses, often billions of dollars. Theproblems have been with the American rather than the UK sub-primemarket, which is better controlled.
This means that major banks are now scrambling to adjust theirbalance sheets so that they will have less funded by money markets andmore funded by deposits. If a bank has any cash, for example fromredeeming mortgages, it will not lend it to any bank that may haveproblems since they are now worried that they may not get it back. Thisis why LIBOR (the rate at which banks are prepared to lend to eachother) is at a level way above the Bank of England base rate. In short,there is not much cash around to fund new mortgage lending.
2. There is a problem of confidence. Lenders fear that as a resultof all the other problems in the market, house prices will fall andthat arrears will get worse. The consequence of this is the tighteningup of criteria. No lender wants to be the last one in the market withwide open criteria.
3. There is an issue of processing capacity. Lender administrationcan run into serious trouble if too much volume is taken on tooquickly. Therefore lenders faced with warning signs of high telephonetraffic or “agreement in principle” levels, have been taking thedecision to adjust rates or criteria, or, in a few extreme cases,shutting their doors for new business.
When will the market “return to normal”?
The short answer is nobody really knows. It is quite possible thatwe will not see any return to the sort of market we had in 2006 and2007 - that market was exceptional with many new aggressive lenders,with big aspirations, making the market compete on riskier terms withlittle or no profit margin. With their departure, the remaining lendersare re-building a more appropriate approach to risk, taking criteriaback to where it was several years ago.
The hope is that perhaps a year or so after the “credit crunch”began, when all the banks have gone through a reporting cycle, all thebad news will be out in the market and the write offs and losses willbe history.
As long as the confidence issue can be handled until that point, we should see lenders becoming competitive again.
Are there any reasons to be cheerful?
There are some positives in the current situation. In the UKemployment is at record high levels (unlike the early 1990s) providinga high demand for housing. At the same time we are not building enoughnew homes. Supply and demand means that the housing market is stronglyunderpinned and is unlikely to crash.
Interest rates are on their way down, with some economistspredicting bank base rate getting as low as 4%. Whether the lower bankbase rate is followed by a fall in mortgage rates is far from certain,but with sufficient cuts the cost of borrowing should get cheaper. Thisis likely to encourage people back into the housing and mortgage market.
Mortgage intermediaries who review the “whole of the market” - likeBlevins Franks - remain the favoured route for consumers to obtainmortgages from lenders. In the current climate advice is needed morethan ever to obtain the best deal possible.
In Summary
There are mortgage lenders who want to lend this year.
Mortgage rates may not fall as fast as the bank base rate.
Larger deposits may be required.
Poorer credit risks will find it more difficult to arrange a newmortgage so keeping a clean credit history has never been moreimportant.
The Bank of England can and is providing more liquidity support into the market - £50 billion announced on 21st April 2008.