Thousands of British homeowners stuck on expensive home loans have been left abandoned after banks said today they aren’t able to offer a way out for the vast majority of mortgage prisoners even if the lending rules change.
Up to half a million mortgage borrowers in the UK have seen their home loan sold onto inactive or unregulated lenders, meaning their mortgage is now owned by a company or fund that can’t offer them a remortgage.
Of those, the Financial Conduct Authority estimates that 140,000 would save money if they were able to switch onto a new deal by remortgaging to another lender.
However, strict rules governing how lenders assess whether they can afford it have left them so-called ‘mortgage prisoners’.
Banks today said the FCA’s plans to help mortgage prisoners would only help a tiny proportion
Following growing pressure from politicians, the financial watchdog has laid out plans to tweak its rule book to allow mortgage lenders to take on these borrowers as new customers.
It is currently in discussions about how best to do this, with its consultation due to close today.
It’s widely expected that the rule change will allow lenders to give affected borrowers a mortgage even if they don’t pass traditional affordability tests, so long as they can show they’re paying their existing loan and the new amount isn’t higher.
But even the FCA itself has suggested that the proposed rule change will only help between 2,000 and 14,000 of the 140,000 borrowers who are currently stuck.
What’s the problem?
Borrowers who were given their deals before the financial crash took place didn’t always have to provide evidence of their income to lenders, could take cheaper interest-only loans without having any way to repay the capital and sometimes, as with Northern Rock Together Mortgages, were allowed to borrow more than the value of their home.
Then the financial crash hit, mortgage lending rules tightened up and now they don’t qualify for a mortgage under the new rules.
Current rules require borrowers to undergo stringent affordability tests when applying for a mortgage.
These include income and expenditure assessments, verification of income, an assessment of future income, and ‘stress tests’ to see if they could keep up with repayment if rates were to rise.
Many customers of closed books cannot pass these tests despite paying their mortgage regularly – even though they currently pay far more each month than they would if they switched.
This is why the Financial Conduct Authority proposed changes to its rules in March. It explored whether to move the assessment from an ‘absolute test’ to a ‘relative test’.
In simple terms, this means if a customer has been keeping up with repayments, they should be able to switch to a cheaper rate (so long as they do not borrow more) regardless of whether they meet the FCA’s tightened affordability criteria today.
This is complicated where these borrowers took a mortgage with a lender that then went bust, sold their mortgage to a third party or simply stopped lending.
In some cases, that means that borrowers’ mortgages are now owned by firms that don’t have regulatory permission to lend, or they don’t offer new mortgage products.
In order to get off a higher reversion rate – typically much more expensive than new mortgage deals on the market at the moment – borrowers in this situation have to move to a new lender.
This hasn’t been possible because the FCA rules mean a lender taking on a new borrower from a different lender has to put them through affordability tests.
The rule change proposed today would mean that lenders could ignore that test and simply say, if the borrower is paying their loan today at this level, we can give them a new loan for the same amount where their monthly payments are lower.
The problem is that there aren’t that many customers who would actually qualify for this situation.
The FCA wants to remove barriers that keep mortgage prisoners from switching deals
Why won’t this work?
Active lenders are extremely hesitant to take on any borrowers who can’t pass affordability checks, for a multitude of reasons. In some circumstances, they are also legally bound not to.
Part of this is down to prudential regulations surrounding how much risk they can take on, and part of this is down to not wanting to take the heat if things go wrong and they ever have to repossess a property.
The FCA’s new proposed rules are also voluntary, not compulsory. As such, if a lender thinks a customer is too risky, they don’t have to lend to them despite the rule changes.
The sticking point here is that some mortgage prisoners would not actually be helped by going onto a new mortgage.
There are lots of different types of mortgage prisoner, but they broadly fall into three different categories, and there are various reasons why lenders wouldn’t want to lend to any of them.
The first group is customers who took out an interest-only mortgage with no way of repaying the loan once it matured.
These mortgages allow homeowners to just pay interest on their loan each month, with the expectation that they will pay the loan back in full once it matures.
Under current rules, lenders cannot offer new interest-only mortgages without a credible repayment strategy – meaning those with no repayment plans will not be able to switch onto another interest-only deal.
One option for these borrowers would be to move onto a longer term capital repayment mortgage, which would be allowed under the proposed rule change.
However, a standard 20-year mortgage would not be enough to reduce monthly outgoings for most borrowers in this situation.
In fact, in its official response to the FCA consultation paper today, UK Finance says that even remortgaging to a favourable rate of 2.30 per cent it would take 29 years for these homeowners to pay off their mortgage – essentially disqualifying anybody over the age of 41, which the vast majority of interest-only customers are.
Unless the customer qualifies for a retirement interest-only loan, it is unlikely they will qualify for a new mortgage.
Around 140,000 mortgage prisoners are stuck with inactive or unregulated lenders
Negative or low equity prisoners
The second group is homeowners with high loan-to-values or who are in negative equity.
This could include customers who took one of Northern Rock’s infamous 125 per cent loan-to-value mortgages, for example.
If the customer has a high LTV ratio on their mortgage, lenders will consider them ‘riskier’ and as such they will be offered loans with a higher interest rate.
In this case the new rates they are offered will be similar to or more than their existing standard variable rate, so there’s little to be gained for this group in remortgaging as they won’t actually save money by doing so.
The third group is those who have either seen a change in their income, or self-certified what they could afford to borrow when they originally took their loans, rather than having their income certified by their lender.
This practice was banned five years ago but many of the original mortgage holders who self-certified are now stuck.
Even if the affordability rules change, those who have trouble proving how much they earn will have a problem getting a mortgage. All new customers will still need to undergo some income verification for anti-money-laundering purposes – this is a legal requirement lenders have to adhere to.
If the customer cannot show where their earnings come from, they will not be able to move to a new lender.
Essentially, rule change or no from the FCA, there are legal requirements on lenders to verify source of funds that would prohibit them from lending to many of these borrowers.
The cost of being a mortgage prisoner
Borrowers who fall foul of affordability rules can find that despite never missing a monthly payment they cannot switch to new cheaper deals.
A household with a £150,000 mortgage, with 20 years left, stuck on a 5.5 per cent standard variable rate and unable to switch to a cheaper 2.5 per cent fixed rate would be paying £1,031 instead of £795 per month.
This would cost them an extra £236 per month or £2,832 per year and if things stayed the same their mortgage would cost an extra £56,900 in interest over the rest of its 20-year term.
Jackie Bennett, director of mortgages at UK Finance, said: ‘The regulated mortgage industry wants to help eligible customers with unregulated or inactive lenders switch to a better deal.
‘We support the FCA’s ambition in its proposals for greater flexibility over affordability assessments and are keen to work with closely with the FCA in a joint implementation group to help those firms who want to participate, prepare and work towards a common launch date.
‘We have suggested the FCA collects up to date information on closed book customers so lenders can understand their circumstances better and develop products that meet their needs.’
Deals to help those who are eligible are not likely to be available until next year.
This is Money recently proposed several solutions, including golden goodbyes, relaxing stress tests, and selling on the debt incurred from negative equity to third parties.
If the remainder of mortgage prisoners, left stranded because the FCA rule change cannot help them, the suggestion is that Treasury will have to extend the FCA’s powers to allow them to regulate owners of mortgage books, rather than just active mortgage lenders.
However, any legislation brought in is likely to be forward-looking, applying to newly created mortgage prisoners rather than those already stuck in inactive books.
Paul Broadhead, head of mortgages and housing at the Building Societies Association, said: ‘At this stage I think it is important to be honest about the challenges and the reality that it will take some time to work through to a sensible conclusion.
‘These borrowers have fewer safeguards than those with regulated lenders and this needs to change.
‘The Government must act now to ensure that these borrowers are subject to the same regulatory protections as they were when they first took out their mortgage.’
The BSA is calling on the FCA and the Government to ensure the sale of any mortgage book from now on does not perpetuate this issue.
As an example of how this practice still occurs, MPs recently asked Tesco Bank to guarantee that the sale of its 23,000 strong mortgage book would only go to an active lender.
The government itself sold off £4.9billion of Northern Rock loans last month to US investment banking giant Citi – classed as an inactive lender in the UK.
After receiving criticism for the move, the Treasury claimed that no active lenders had been interested in the sale, despite being invited to bid.
Head of policy for debt charity Step Change Peter Tutton said: ‘The FCA’s principle of making it easier for mortgage prisoners to switch is great, but it won’t work in practice for some of those in the greatest need of help.
‘If people are on “closed books” with inactive or unregulated lenders and fall outside other lenders’ risk appetite, they don’t qualify.
‘Given that these types of trapped customers are likely to be those who could benefit most from lower costs, we think greater intervention is justified, even if further legislation is needed to achieve it.’
How the financial crisis happened
In this episode of the This is Money podcast, editor Simon Lambert discusses the credit crunch and financial crisis with Georgie Frost.
Simon relives reporting on the crash of Northern Rock, on the credit crunch as it unfolded, the events that led up to it and the financial crisis that followed.
He also tackles the billion-pound bailout question: Could it happen again?