Posted on 11 February 2015 by
The February edition of Which? reviews financial products targeted at the over 50s. However, Which? demonstrates its ignorance of this part of the mortgage market in a article entitled “Overpriced for the over-50s”, which looks at how equity release compares with what it considers as alternatives.
The nub of the Which? criticism is that lifetime mortgages are too expensive and it comes to this conclusion by comparing the interest rates on offer with fixed rates available on “standard” mortgages. The logic of this criticism is on a par with saying that 5 and 10 year fixed rates are too expensive because the rates are higher than 2 year fixes.
As lifetime mortgages have many differences to other fixed rate mortgages the comparison Which? has made is breathtakingly naive but is perhaps not surprising, bearing in mind the lack of objectivity Which? has previously demonstrated when writing or commenting about lifetime mortgages.
The Which? article provoked Andrea Rozario, former Director General at the Equity Release Council, to make some very inciteful and pertinent comments and in particular the regulator should reflect on these two sentences: “Firstly, due to the impacts of the Mortgage Market Review, the over-55s are finding it much harder to get a ‘standard mortgage' and rejection because of affordability issues is not uncommon. Therefore, for those who are being turned down for a ‘standard mortgage', a comparison of interest rates between ‘standard mortgages' and equity release is wholly irrelevant.”
The FCA claims that there is nothing in the MMR to stop lenders offering mortgages to this cohort of borrower, whereas all the major lenders cite the MMR as their excuse for not doing so. However, as some of the smaller manually underwriting building societies apply varying degrees of common sense to this sector of the market, rather than adopting the “computer says no” approach of the big boys, this suggests it is fear of the regulator rather than the actual regulations which is the problem.
Since the FSA was split up into a conduct regulator and a prudential regulator the FCA has said it will place more focus on achieving good consumer outcomes and that simply making sure all the boxes are ticked is not enough. This is an admirable aspiration but it is clearly a long way from being achieved if even those mainstream lenders which are prepared to lend on an interest only basis consider the regulator prevents them from doing this type of typically very low LTV, and hence negligible risk, lending, to older borrowers.
Perception is everything and whether or not most mainstream lenders’ fears about the impact of the MMR on lending to older borrowers are justified the fact is that in this context the MMR is having a huge negative impact on consumer outcomes, the exact opposite of what the FCA says its objective is.
The two main regulatory requirements for an interest only mortgage are that, like any other mortgage, it is affordable and that there is a robust repayment strategy. The problem with the way some lenders calculate affordability is that even when the repayment strategy does not require a monthly investment the calculation is done on a repayment basis. Thus, although a borrower in their 60s might only want a 5 or 10 year term, easily affordable on an interest only basis, the lender says it is not affordable because their calculation is done on a very short term repayment basis.
As for having a robust repayment strategy if a longer term mortgage is required, I can’t think of any repayment strategy which is more robust than that the property will be sold when the last borrower (if there is more than one) dies or goes into care.
This seems a somewhat more robust strategy than lenders are prepared to accept when lending money to the UK Government, in the full knowledge that the Government will have to borrow more money just to pay the interest, let alone repay the capital!
There are likely to be some regulatory definition changes for the lifetime mortgage market in March 2016 as a result of the EU Mortgage Credit Directive, although fortunately the tentacles of the EU excluded any specific regulation for lifetime mortgages. Some convergence of the regulations for standard and lifetime mortgages would undoubtedly facilitate the designing mortgages geared to the older borrower with appropriate features not currently freely available.
Assessing affordability into retirement will be more challenging following April’s changes in the pension rules. This is because in future it is likely that the new freedoms will result in a smaller proportion of income in retirement being in the form of a normal pension/annuity and more from other investments, including ISAs.
This presents a problem for most lenders as they ignore investment and savings income on the basis that the borrower could go out and blow the capital on a Lamborghini. Such an approach will have even less validity in future as people will soon also be able to blow their pension pot as well, although of course in practice few people sensible enough to save for their retirement will do such a thing.
I see no logic in the FCA forcing lenders to apply the same degree of affordability checks to a low LTV mortgage, especially for a retired person with significant funds used to generate retirement income, as to a FTB requiring a 95% LTV mortgage but with little or no savings after funding the deposit. The MMR fails to reflect the fact that the risks to the lender are completely different.
Many retired people with significant savings or investments are likely to be better off using some of their funds to repay their mortgage, but others will prefer to retain a mortgage for various reasons.
For some retired borrowers a roll up lifetime mortgage will be an ideal solution and because of the low maximum LTV available on such mortgages their equity, in cash terms, will often still increase even if all the interest is rolled up, something which perennial detractors of lifetime mortgages, like Which, fail to comprehend. Maintaining the equity in cash terms is of course not guaranteed but in most cases it only requires a historically low rate of increase in the property value for this to be achieved.
Other borrowers will prefer a long term “standard” interest only mortgage, but may not be able to obtain one and as a result choose one of the lifetime mortgages which allow overpayments to be made, effectively allowing them to obtain the interest only mortgage they wanted, but with some features automatically included they don’t need, which is reflected in the interest rate.
For example borrowers in this category have much less need of a no negative equity guarantee than an FTB borrowing 95% LTV, although of course such a guarantee is not available to the latter even if they wanted it.
Now that several lenders are offering the hybrid mortgages referred to above, where some payments can be made, the next innovation in the lifetime mortgage market should be a menu approach, thus allowing borrowers to pick what features they want so that they pay for those they want but not for those they don’t.
Such innovation could have presented a challenge for the Equity Release Council (ERC) as a mortgage with a menu approach would not meet all the conditions it specifies, but it has taken a pragmatic line on this and one of its members already offers a mortgage which doesn’t qualify as being ERC compliant.
The standards required for a mortgage to be classed as ERC compliant have been an important safeguard for borrowers for many years but nothing is forever and as regulation changes and the market moves on there is scope for a new range of lifetime mortgages.
It will however be critical that it is made absolutely clear to potential borrowers which mortgages carry all the ERC guarantees and which don’t. This will help advisers highlight to borrowers which ERC features are excluded from a particular mortgage in exchange for what should be a lower, or different type of, interest rate.
It might be helpful for the ERC to develop a standard check list of various possible lifetime mortgage features, including some not currently available, with a requirement that its members should provide with each illustration, perhaps as an addendum to the KFI, a list with a tick or cross against each feature to show whether it is available with that mortgage.
The views expressed here are those of the author and do not necessarily represent or reflect the views of John Charcol Ltd
The blog postings on this site solely reflect the personal views of the authors and do not necessarily represent the views, positions, strategies or opinions of John Charcol. All comments are made in good faith, and neither Charcol Limited nor Ray Boulger will accept liability for them.