Outlook for the mortgage market

2007 was a year of two halves for the housing and mortgage markets. In the first half of the year, the market was slower to react to the rising trend in interest rates than many commentators expected. Strong competition and innovation amongst lenders continued to help borrowers access the market. As a result sales held up and annual house price growth edged up to over 10%.

By the end of the year the market was much more subdued. Interest rate rises started to weigh on the market and by the end of the year the “credit crunch” was clearly starting to have an impact. The disruption in the credit markets has resulted in funding difficulties for a number of mortgage lenders, reducing their capacity to lend. Lenders have reappraised the risks involved in lending, and had to tighten lending criteria and widen mortgage margins to some parts of the market.

The combined impact of rising interest rates and the tightening availability of mortgages has been a sharp fall in mortgage approvals for house purchase, a weakening in house price growth, and mortgage lending volumes falling below the levels of a year earlier.

At the end of 2007 house annual price growth came down to 6%. Housing market turnover was broadly in line with expectations. Data for the fourth quarter of last year is not yet available, but our estimate is that there were 1.17 million transactions in England and Wales in 2007. The strength of prices in the first half of the year, and remortgaging up fro a year ago, helped lift gross lending for the year to £362 billion.

Forecasting the outlook for the housing and mortgage markets in the current climate is more problematic than usual. However, in October last year we published forecasts to the end of 2008 (a summary of which is below) and will extend our forecasts to 2009 during the first quarter of this year.

Forecast summary

Source: Bank of England, National Statistics, HM Land Registry, HBOS, CML

Notes: (1) Figures for arrears and possessions are estimates and relate only to first charge lenders who are members of the CML. They do not include arrears and possessions relating to other secured lending or to firms that are not CML members.

The extent to which lenders will be able to meet mortgage demand in 2008 remains uncertain, as does the strength of demand itself. The uncertainty over the future course of house prices is likely to deter the demand for house purchase. And the introduction of home information packs is likely to hold down the number of sales by dissuading speculative sellers from marketing their properties.

On the positive side, interbank rates have started the year at lower levels relative to the bank rate than for many months. As yet it is not clear if this will continue, but central banks have shown their determination to bring interbank rates down. We would warn, however, that interbank rates may not be an accurate guide to the level of distress in the financial system. There is limited lending in the interbank market and, while it allows funds to transfer from one bank to another, in aggregate it cannot add to the funds available to banks. Key wholesale funding markets – mortgage backed securities (MBS) and covered bonds – are still shut. Reopening these markets will be critical to restoring the full health of the banking system and ensuring the supply of credit to the retail mortgage market. The restoration of these funding markets is also a necessary condition before a private sector solution can be found at Northern Rock.

2008 will be a challenging year for the mortgage market. While there are significant downside risks, there are reasons for optimism. Interest rates are falling and are likely to continue to do so. It is also possible that the worst of the problems for mortgage supply could be behind us by the middle of the year, and sentiment will stabilise and slowly start to improve as the year progresses.

Bank base rate and mortgage rates

Earlier this month the prime minister and the chancellor made some highly-publicised comments urging lenders to “pass on” interest rate cuts to mortgage customers. Most mortgage customers are on fixed or tracker rate products where the lender’s decision about whether to change variable rates is irrelevant. And the factors that determine lenders’ rate-setting for the minority of borrowers who are on a standard variable rate are more complex than simply the level of the bank base rate. Lenders must consider their own cost of funding from savers, and the price and availability of funding from wholesale sources.

By limiting the availability of wholesale funding, the “credit crunch” has required lenders to compete more aggressively for retail funds, driving the price up relative to the base rate. Where wholesale funding is available it is also more expensive relative to the base rate than it was.

It is therefore incorrect to assume that a base rate reduction will (or should) automatically result in a cut in standard variable rates or discounted rates. Tracker rates will automatically change if they track the bank base rate, while fixed rates are determined by the market cost of fixed-rate funding rather than by the bank rate.

Sale and leaseback schemes

We, along with Shelter and Citizens Advice, have called on the government to require the FSA to regulate sale-and-leaseback schemes. These schemes allow owner-occupiers to sell their homes to a company and then to remain in the property leasing it back. However, there are concerns that many sale-and-leaseback schemes offer very little security of tenure, and properties are often purchased at a discounted rate without an independent valuation. Some schemes have also been criticised for the way in which they treat consumers at a potentially vulnerable time when they may be facing repossession.

Controls exist for action taken by mortgage lenders when customers are in arrears, but there are no such safeguards for customers entering into sale-and-leaseback schemes. In a climate of rising repossession, consumers in financial difficulty need to be well informed and protected. The government needs to consider urgently whether regulation of sale-and-leaseback schemes by the FSA is appropriate to provide protection for potentially vulnerable consumers.

Sustainable home-ownership

Our arrears and possession figures for the second half of 2007 will be published on 8 February. We do expect payment difficulties to increase in the short term. This is because of interest rate rises since August 2006, the prospect of widespread payment shock facing borrowers on maturing fixed-rate products, and reduced availability of refinancing options available to some borrowers.

Our forecasts suggest a rise in the number of loans in arrears of more than three months from 120,500 at the end of 2006 to 145,000 at the end of this year and 170,000 at the end of 2008. The number of possessions taken by first-charge mortgage lenders is forecast to rise from 22,700 last year to 30,000 this year and to 45,000 in 2008. This will be the highest level of possessions since the mid-1990s, but it is worth noting that over the same period, the number of mortgages will have increased by nearly 1.5 million.

With affordability pressures increasing on all purchasers, particularly first-time buyers, sales of mortgage payment protection insurance (MPPI) have been falling. Only 20% of all loans are now covered by insurance, and the continuing investigations of payment protection insurance generally by the Financial Services Authority and the Office of Fair Trading could erode take-up of MPPI further.

At the same time the coverage of the mortgage safety net in the UK is looking increasingly inadequate and state support for home-owners in difficulty has been largely withdrawn. Under some circumstances, the state may step in and contribute to claimants’ mortgage interest payments through income support for mortgage interest (ISMI). But ISMI was cut back significantly in 1995 and can now only be claimed after a delay of nine months, and up to a maximum mortgage sum of £100,000. The government has not increased this threshold since 1995, and the overall level of support for home-owners has dwindled to its lowest level for more than 20 years.

We believe there should be a review of ISMI to reflect the current market. If the maximum mortgage limit had been indexed in line with retail price inflation it would now stand at £142,000, or around £300,000 if it had been linked to house price inflation. The government could also consider whether ISMI could be registered as a charge against the property to be reclaimed when the property is sold.

While lenders have a duty to lend responsibly, and borrowers have a responsibility to manage their financial affairs to the best of their ability, problems still occur. The industry is continuing to explore what more it can do to help borrowers who find themselves in difficulty, but it is time for the government to play its part to ensure that as many people as possible can stay in their properties in what is likely to be the most challenging period for sustainable home-ownership since the Labour government came into power.

Low-cost home-ownership

The government have developed a range of low-cost home-ownership (LCHO) schemes, but unfortunately these schemes have become increasingly piecemeal and complex. Lenders are finding it increasingly difficult to deal with this patchwork of schemes. Their systems are becoming more automated and less able to incorporate small schemes benefiting relatively small numbers of people.

Complicated schemes that have to be underwritten manually are likely to attract the involvements of only a small number of lenders, restricting choice for consumers. And complexity adds to costs, meaning lenders may not be able to offer the cheapest loans possible.

We have therefore urged the government to simplify the range of schemes available. We would also encourage government to remind local authorities of the model 106 agreement published by the DCLG in August 2006. Restrictive covenants potentially constrain both lenders and borrowers, and may make it more difficult to obtain a mortgage on some properties.

On shared equity, we would like to see the government’s efforts go into publicly funded schemes linked to new supply, like English Partnership’s first-time buyer initiative. The open market homebuy scheme launched in 2005 has proved complicated and unpopular. The lenders involved in it have put considerable resources into overcoming the challenges, only for government to change the parameters before allowing the pilot to run its course.

Treasury’s housing finance review

We welcome the Treasury’s review of wholesale funding for mortgage lenders. Innovations in mortgage funding are a key driver for new types of mortgages, so the Treasury is right to examine this area. Whether the government’s plans to introduce covered bond legislation will help to increase the flow of 25-year fixed-rate deals remains to be seen.

Long-term fixed-rate deals are not a new idea, and some mortgage lenders already offer these products. The issue is just as much about the consumer appetite for long-term fixed rates as about how they are funded. Lenders have found that long-term fixed-rate loans have not proved to be as popular with customers as discounted variable or short-term fixed-rate products. Equally, brokers are not currently incentivised to sell long-term fixed rate products, so consideration will also need to be given to how we can overcome this.

It is too early to say whether the government’s plans will create a significant shift in the design of the mortgage products of the future. We look forward to working closely with the Treasury on this issue.

28 January 2008