Short-term mortgages are great for some, but their prevalence is exacerbating challenges for first-time buyers, writes Elliot Reader, senior vice president at Houlihan Lokey
In the UK’s mortgage market, short-term lending dominates. The prevalence of short-term, fixed-rate mortgages has entrenched itself as a defining characteristic of the housing market – and for good reason. These types of mortgages serve large segments of the market effectively. However, it’s becoming increasingly apparent that by solely relying on these two-to-five-year products, certain groups are left underserved, exacerbating challenges particularly for first-time buyers who face rising house prices and a lack of suitable retirement-focused products. Rather than advocating for a complete overhaul of the UK system, the focus should be on integrating new methods to address these gaps.
Without a pivot in funding models, which sits at the heart of this issue, the UK risks perpetuating the situation and allowing crucial demographics to be left behind. The largest mortgage lenders in the UK predominantly fund their lending through current accounts and short-term fixed-rate deposits. As we have seen in recent times, liquidity stresses arise due to potential deposit withdrawals, necessitating costly and sometimes inefficient swaps, and limiting covered bond funding volumes, which ultimately leads to limited product innovation.
For decades, short-term fixed-rate mortgages have been widely favoured, with the two-year fixed rate traditionally being the most common option. Borrowers often start with a “teaser” rate before transitioning to a higher contractual reversion rate, with around 2m fixed-rate mortgages due to mature before the end of 2024.
The continuous upward pressure on house prices, reaching more than ten-times the average income, has made homeownership increasingly challenging, particularly for first-time buyers who typically require high loan-to-value (LTV) and loan-to-income (LTI) ratios. Affordability stress tests introduced in 2014 have compounded this issue, leaving millions of potential first-time buyers unable to afford a home. Existing lenders often stress affordability at rates as high as SVR+ three per cent, severely limiting borrowing capacity. As a result, the prospect of homeownership remains elusive for a growing segment of the population.
Adding to this is the looming spectre of interest-only mortgages maturing, with around 40,000 of such products due to mature each year until 2032. For those over 65, this poses a precarious situation, with no follow-on products available, forcing them into a corner where selling their homes may become the only viable option. This scenario not only underscores the gaps in the current mortgage ecosystem but also highlights the urgent need for innovative, long-term mortgage solutions.
To break this impasse, it’s imperative that new methods are integrated into our banking system. Other European countries, including Spain and Belgium, have developed efficient long-term fixed-rate mortgage markets, typically funded by institutional capital from pension funds and insurance companies. Such products 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.
It’s crucial for brokers to acknowledge that long-term mortgages aren’t just a product of last resort for first-time buyers or later-in-life borrowers; they represent a viable alternative that offers a different solution for customers. In this context, the lowest rate shouldn’t be the sole differentiating factor it has historically been, as the alternative solution it offers may still be viewed favourably by the end customer.
Adjusting commission incentives accordingly is important, especially considering that a long-term product doesn’t fit the current broker incentive structure. Notably, for long-term products, there needs to be a trail commission structure, akin to an annuity, which incentivises the adoption of longer mortgages over shorter two-to-five-year products.
The emergence of capital raise activities aimed at addressing these gaps underscores a growing recognition of unfulfilled potential in the market. We anticipate a shift where high street banks will explore tapping into pools of liquidity to access these products and mortgage offerings. This evolution is not merely about expanding market share; it’s about developing the very essence of mortgage lending in the UK.
The journey towards resolving the UK’s housing crisis necessitates new and innovative products to address the gaps. Current issues will only continue to be exacerbated unless banks can pivot their funding models and offer flexible mortgage solutions that meet the requirements of the public.
The ability to address the specialist end of the market remains an in-demand capability.
