In the UK’s mortgage market, short-term lending dominates. Specifically, two- to five-year fixed rate mortgages have entrenched themselves as a defining characteristic of the housing market.
While these products effectively serve large segments of the market, they also leave certain groups underserved. Notably, first-time buyers facing challenges due to rising house prices and a lack of suitable retirement-focused mortgage options.
Rather than advocating for a complete overhaul of the UK system, the focus should be on integrating new methods to address these gaps.
Funding restrictions on lending
At the heart of this issue lies the funding model. The largest mortgage lenders in the UK primarily fund their lending through current accounts and short-term fixed rate deposits.
However, this reliance on short-term funding sources can lead to liquidity stresses, as we have seen. Potential deposit withdrawals necessitate costly swaps, limiting covered bond funding volumes and ultimately hindering product innovation.
For decades, short-term fixed rate mortgages have been the norm in the UK, with the two-year fixed rate being the most common option. Borrowers often start with a “teaser” rate before transitioning to a higher contractual reversion rate. Approximately two million fixed rate mortgages are due to mature before the end of 2024.
The continuous upward pressure on house prices, which now exceed 10 times the average income, has made homeownership increasingly challenging. First-time buyers typically require high loan-to-value (LTV) and loan-to-income ratios, but affordability stress tests introduced in 2014 have compounded this issue. Millions of potential first-time buyers find themselves unable to afford a home. Existing lenders often stress affordability at rates as high as the standard variable rate (SVR) plus 3%, severely limiting borrowing capacity.
Consequently, the dream of homeownership remains elusive for a growing segment of the population.
Adding to the complexity is the impending maturity of interest-only mortgages. Approximately 40,000 such products are due to mature each year until 2032. For homeowners older than 65, this poses a precarious situation; with no follow-on products available, selling their homes may become the only viable option. This scenario underscores the gaps in the current mortgage ecosystem and highlights the urgent need for innovative, long-term mortgage solutions.
The stability of the long-term mortgage
To break this impasse, the UK banking system must integrate new methods.
Other European countries, including Spain and Belgium, have successfully developed efficient long-term fixed rate mortgage markets. These markets are typically funded by institutional capital from pension funds and insurance companies. Long-term fixed rate mortgages provide stability and predictability for borrowers while reducing risks associated with short-term rate fluctuations. By diversifying funding structures and embracing innovative distribution networks, lenders can expand their offerings to better serve the needs of aspiring homeowners and address the challenges posed by the housing crisis.
Brokers play a crucial role in this transformation. They must recognise that long-term mortgages aren’t merely a last resort for first-time buyers or older borrowers. Instead, they represent a viable alternative that offers a different solution for customers. In this context, the lowest interest rate shouldn’t be the sole differentiating factor. Brokers should consider innovative solutions that benefit customers beyond just rates.
Adjusting commission incentives to support long-term products is essential for sustainable change.
The journey towards resolving the UK’s housing crisis necessitates new and innovative products to address the gaps. Current issues will only continue to exacerbate, unless banks can pivot their funding models and offer flexible mortgage solutions that meet the requirements of the public.
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