With remortgaging levels still high, many borrowers are using it as a vehicle to raise low-interest capital. But how do lenders view the risks?
The remortgage genie is out of the bottle and no matter how hard lenders try to put it back in, they will be left wanting. Lenders have themselves educated the consumer into the benefits of remortgaging. This effectively means they have shortened the average life of a mortgage ' and its profitability ' because borrowers increasingly understand the benefits and ease of switching their mortgage to another lender.
Most lenders accept that, from an industry perspective, this is not in their best long-term interests, but are a long way from knowing how to avoid the pressures to compete vigorously in the remortgage market. Hitting this and next year's lending objective, without a big push on remortgage business, is placing hurdles in the way that need not be there. Let us face it, if one lender stops targeting the remortgage market, this will not stop other lenders pillaging their mortgage book.
Lenders have been particularly effective at promoting remortgages, and borrowers fully understand the primary reasons to take a mortgage with another provider. The main motivators fall into two categories ' to benefit from a cheaper mortgage, or to raise finance from the increased equity in the property.
Lenders' branches used to be allocated a quota of mortgage funds and if you wanted more you had to ask head office nicely if it could spare the extra funds. These days lenders are competing for every mortgage, spelling great news for both consumers and lenders as it drives greater efficiencies and promotes good practice. As a result, most mainstream, and probably the majority of non-mainstream, borrowers will not find it difficult to remortgage.
The credit boom
There is no doubt that raising finance against your property is the cheapest way to borrow money. It is much cheaper than an unsecured or secured loan or building up a debt on credit cards. Interestingly, while the mortgage market is booming, it is also true other forms of credit are doing equally well.
Howard Davies, head of the Financial Services Authority, has already expressed concern at the extent of the consumer credit boom and it is something the Monetary Policy Committee will be scrutinising on a monthly basis.
The credit boom is being fuelled by historically low interest rates, rampant house price growth, low unemployment and the fact that pay is growing faster than inflation. This means there is still untapped potential in the remortgage market for debt consolidation.
With the mortgage base rate hovering below 5% and additional discounts reducing this further, the merits of raising an unsecured loan at 8% upwards or paying interest of nearly 20% on a credit card ' many of the big banks are still charging some eye-watering rates which many consumers passively accept ' look pretty thin.
In fairness, credit card customers with higher debts will not be homeowners and so remortgaging to consolidate the debt is not an option. Mortgage lenders should view the record volumes of non-mortgage debt being taken out now as a potential stream of customers in the future as, in due course, there is the likelihood that borrowers will wish to consolidate their debts at a future date, especially if there is some form of downturn in the market and consumer confidence wanes. This is when debt consolidation will become really popular.
The risk factors
Remortgaging can be used for raising finance for many purposes other than debt consolidation:
• Home improvements such as double glazing, central heating or extensions.
• Furnishings such as new carpets, a new sofa or television.
• Quality of life factors such as the holiday of a lifetime, funding a child through university or, increasingly, to finance private education.
• Purchasing a second home for buy-to-let purposes or to accommodate aging parents. Although there is no shortage of specific buy-to-let mortgage products to address this sector of the market, it makes sense to add it to the existing mortgage to keep costs to a minimum.
• Raising finance to support a business.
Lenders will underwrite the remortgage application differently depending on the purpose of the finance being raised. Improvements to the fabric of the property will, from the lender's perspective, be the lowest risk given that such improvements will increase the value of the lender's security. Other improvements like decorating or furnishing do not enhance the value of the property, but are not regarded as high risk factors. Raising finance for debt consolidation would, by most lenders, be regarded as higher risk lending because it, in some instances, will be a consequence of bad financial planning. However, without question, the highest risk factor of those listed is to lend money to support a business venture.
The risk factors are reflected in the LTV limits applied by lenders. Many lenders will provide remortgages up to 95% of the property value, which is 5% higher than the normal figure that applied five years ago. There is a great deal of diversity in the market with regards to the maximum loan to value available for remortgages required for different purposes.
Some lenders also have differential LTVs for borrowers raising funds for second properties. Nationwide, for example, limits its loans to 80% for remortgages for second homes.
The figures in table one demonstrate the different risk characteristics associated with the different purposes of a remortgage advance. Business loans are risky because mortgage underwriters have little expertise in underwriting commercial loans ' something normally left to the specialist business loan departments of the high street banks ' and also because raising business funds on a home can be the last resort to prevent the business going into liquidation. With as many as one-third of businesses not succeeding, it is all too apparent why lenders are either not prepared to lend for this purpose, or at least attributing higher risk factors to such lending.
Debt consolidation is less risky than lending for business but higher risk than home improvements or simply switching the mortgage for those borrowers wishing to benefit from a better rate.
One of the reasons why lenders have been sufficiently confident to relax criteria on remortgages, apart from the additional security factors associated with credit scoring ' which an increasing proportion of lenders rely on ' is the overall improvement in the bad debt experience. While this might partly be as a result of the improved financial climate, it also reflects that many financially astute individuals are managing their borrowings in a more educated manner by churning their mortgage. The profile of the average remortgage borrower has changed. These days the borrower seeking a remortgage is not the poor financial manager that was once the typical applicant.
The market continues to develop at a significant rate and it will be interesting to see what will happen if there is a downturn in consumer confidence due to a market correction in house prices, rising inflation or some other factors. However, whether the market is buoyant or depressed now the remortgage genie is out of that bottle there will be a strong appetite to remortgage.
In a buoyant market, consumers will want to borrow to spend and improve their lifestyle and in a depressed market borrowers will want to reduce their outgoings.
Stuart Glendinning is a director of Mortgage 2000, moneysupermarket.com and the Professional Advisor Alliance
With mortgage rates so low, remortgaging currently provides the cheapest way to raise extra capital.
Lenders underwrite remortgage applications differently depending on the purpose of the finance being raised.
Lenders view raising cash for business ventures or debt consolidation as high risk and home improvements as low risk.
Tracking real performance
Diversified return team
The equivalent of £1.7m every day
Janus Henderson Global Dividend index