As the new year gets underway in earnest, our mortgage team considers some of the key issues and developing trends affecting the UK residential mortgage market.

A busy start to the year

Coming into 2019, there is plenty to keep the regulatory teams in mortgage firms busy, with no less than five major workstreams which have recently come to a head or are awaiting completion:

  • Just before everyone went away for Christmas, the Financial Conduct Authority (FCA) published its final report Strategic Review of Retail Banking Business Models (which had a specific focus on mortgages), following the release of its progress report in June 2018.
  • The final findings of the FCA’s Mortgage Market Study (MS 16/2) are expected in Q1 2019, following the interim report released last May.
  • A consultation paper is expected in Q1 2019 to follow on from the FCA’s discussion paper on Price Discrimination in the Cash Savings Market (DP 18/3).
  • At the end of December, the Competition and Markets Authority responded to the Citizens Advice super complaint relating to concerns about long-term customers paying more for goods and services, by setting out a package of reforms and making recommendations to the FCA.
  • The FCA’s discussion paper looking at Fair Pricing in Financial Services (DP 18/9) requires a response by January 31, 2019.

Helping prisoners escape

Inevitably, one of the key focuses of the mortgage industry has been the interim results of the FCA’s mortgage market study published in May last year. One key theme was that of mortgage prisoners, who are longstanding borrowers trapped on a reversion rate who are unable to switch to a better deal, due in part to the changes to affordability criteria under the Mortgage Credit Directive.

In July 2018, UK Finance helped coordinate a voluntary arrangement for active lenders, comprising 93% of the UK’s residential mortgage market, who agreed to pro-actively contact their customers by the end of 2018 if they were on a reversion rate and could have moved onto a better deal.

However this still leaves the problem of the approximately 20,000 customers with inactive lenders and 120,000 customers with unregulated lenders. It does raise a question around mortgages that have been originated on behalf of, or assigned to, unregulated investment funds that do not have the capability (or incentive) to allow these customers to move. We understand the FCA are investigating whether it has enough powers in place to do anything about this, and Andrew Bailey, CEO of the FCA, recently wrote to the Treasury Select Committee to state that the FCA will consult on changes to its responsible lending rules with the aim to deliver a more proportionate affordability assessment, based on a relative (rather than absolute) test.

Fixing the leasehold market

The topic of leasehold reform continues to be a major point of discussion, following the government consultation in 2017. There are currently two consultation papers on remedies, one from government and one from the Law Commission, with legislation expected in 2019.

The government consultation includes looking at banning the unjustified use of leaseholds for houses, capping the level of ground rent, putting measures in place to make charges transparent and improving the process for how leasehold properties are sold (such as through a fixed level of charges). Our understanding is that the industry is broadly supportive of the ban on leasehold houses, but that there are some cases where leasehold housing should be supported (shared ownership schemes being the obvious example). Given that the government has already been putting pressure on chargers of very high ground rents, proposals to limit excessive charges are likely to have a bigger effect on the mid-level ground rents. Proposed methodologies to achieve the suggested limits vary within the industry, with certain providers favoring capping ground rents at a percentage of the property price, with others preferring a fixed monetary limit.

The Law Commission consultation looks at enfranchisement to buy leasehold properties, including seeking to provide a better deal for leaseholders by making the process of enfranchisement easier, quicker and more cost effective, reforming the existing rights of leaseholders (including removing the separate rules for houses and flats) and simplifying and reducing the costs of acquiring a leasehold or an extended lease. This consultation has recently closed, and we await the findings in due course.

Trying times for buy-to-let

The last few years have seen significant changes in the buy-to-let market. The result was a significant contraction in the market in 2018, which was even more severe than expected with a current market size of GBP9 billion compared with a forecast of GBP12 billion.

The stamp duty changes on second homes is widely accepted to be a major factor in this decline, but other factors have also squeezed the sector, including:

  • The Prudential Regulation Authority’s underwriting requirements introduced in 2017;
  • The upcoming changes to buy-tolet mortgage interest tax relief;
  • The minimum energy efficiency standards; and
  • The expansion of House in Multiple Occupation licensing.

LIBOR issues for residential mortgage providers?

With LIBOR coming to an end in 2021, to be replaced with risk-free rates such as SONIA, traditional thinking has been that this is unlikely to be an issue outside of certain buy-to-let mortgages and a handful of legacy residential mortgage contracts.

However, some industry insiders believe that this could be a bigger issue than is generally appreciated, particularly on the residential loans side. With authorities telling the industry that it needs to sort this out itself, and with the upcoming guidance from the FCA expected on contract variation (noteworthy where lenders may be expecting to rely on unilateral rights to vary reference rates as a response to decommissioning LIBOR), pressure is likely to come onto lenders to assess their mortgage portfolio to know exactly what they have on their books and what contractual amendments might need to be made (and how).

What to watch out for

Later life lending and vulnerable customers are two areas which we may see further regulatory developments next year.

Later life lending is an increasing part of the market, with new residential loans to older borrowers high and still growing, and there has been a general resurgence in equity release products. New residential mortgages where the term ends after the borrower reaches the age of 65 have grown quite significantly. March 2018 saw the FCA treat retirement interest-only mortgages as standard mortgages rather than under equity-release standards in an effort to broaden product choice in this sector, and it is possible further developments will follow.

The FCA is also revisiting the topic of vulnerable customers, following the publication of its Approach to Consumers paper in 2018. We are expecting an FCA consultation on vulnerability guidance some time in 2019.