In the past six weeks, the mortgage industry has witnessed the most remarkable about-turn by the Council of Mortgage Lenders. Initially, it recommended that interest rates should be increased to control the continuing growth of house prices, completely ignoring the impact such a move could have on arrears. Then, like Paul on the road to Damascus, it saw the light and warned its community that just such an increase would definitely occur next year after interest rates rise. It raised the very real fear of a repeat of the repo levels of the early 1990s.
As I write, the prospect of imminent interest rate hikes, which might test some of the looser underwriting the market has witnessed, has faded. However, the question remains as to whether the combination of higher income multiples, high loan to values and the resurgence of self-certification will raise repo levels and, indeed, whether this represents responsible lending.
Despite the weakened economic outlook, the risk of a huge rise in in repossessions is unlikely to recur. Interest rates are fundamentally affordable today. Even though payment shock arising from eventual interest rate rises will lead to increased arrears, most lenders have improved their arrears' management significantly in the past decade. Earlier and more responsive action here is preventing many cases going into repossession.
Nevertheless, as lenders continue their quest for growth, price and credit remain their principal tools. Much has been made of the increases in income multiples, with evidence of multiples of over five times income being cited. The professionals' market has long had this feature because of the expected profile of earnings growth for such borrowers. Recently, however, house price inflation has driven its application into a broader market.
These loans just about pass current affordability tests but it seems to me that they would fail any stress test. First, the prospect for earnings growth is much reduced, even for young professionals. So, it is going to take considerably longer before the loans become affordable. Second, a disadvantage of low interest rates is the increased risk of payment shock. If rates rise by 1 per cent, the monthly cost of interest-only mortgages increases by 20 per cent on normal rates and up to 35 per cent on discounted products. Good arrears managers will tell you that such payment shock is a major cause of arrears. Unfortunately, underwriters do not always seem to appreciate this.
Sectors of the market do need these multiples and the solution is remarkably simple. High income multiples become far safer for both borrower and lender if they are only available with minimum five-year fixed rates. You cannot argue with the logic unless you are one of the many brokers for whom two-year deals are always best advice so that you get to churn.
As for loans already out there, an inevitable increase in repos will happen in a couple of years time – a tragedy for the small number of borrowers affected, which sensible lending could have avoided.
Another potential risk is a repeat of the late 1980s practice of allowing employed borrowers to self-certify their income. This is happening more as borrowers want to raise more debt and crucially because brokers love these products. There are no hassles over what constitute bonuses and no packaging issues on income verification. Bizarrely, the less favoured non-status loan without income confirmation has more integrity. When these loans, which face similar affordability challenges to high multiple loans, go into arrears, lenders pounce quickly to mitigate their losses.
In a couple of years, we may not be reading headlines about massive increases in repossessions but there will be a number of personal tragedies for families losing their homes. It could all have been avoided with a small application of brainpower and decent mortgage advice.
Mark Chilton is an independent mortgage consultant