After a prolonged period of growth in the economy and an unprecedented rise in house price, the financial crisis of 2007 created a profound change in the banks’ lending policy in the UK. This did not really assist in the recovery of the economy. However, it was designed to prevent a further slide down into a more indebted nation. Many of the previous trends in lending that had contributed to the rapid rise in prices were reversed. These affected the government, businesses and ordinary households.
House prices had reached a peak just before the crash. It showed a growth from the middle of the 90’s up to 2007. This affected house prices in other countries as well as the UK. The sudden decline in the housing market had not been foreseen even though there had been warnings from economists that it could not last indefinitely. There were no exceptions though. As a result, house prices virtually fell of the edge of the cliff once the big banks stopped lending to each other.
Changes to Mortgages
The first change to mortgages was seen when interest rates increased as lenders began to assess the risks of future non-payment. Or, they refused to grant mortgages. Those banks that received funds from money markets to give out as mortgages had to increase rates because they were paying a higher rate for the funds. Once house prices began to fall and continued to do so, new mortgages were granted against a home (collateral) that was expected to decline in value. Banks that already held riskier assets were forced to increase their reserves. This meant they had a reduced amount of money to lend.
Higher Risk of Negative Equity
In addition to these problems the borrowers who had taken out loans were already experiencing a higher risk of negative equity. This included those people who had withdrawn equity from their house to pay for home improvements or other things like cars. Some of these problems were offset when interest rates began to fall. However, the market was rife with uncertainty and change. This uncertainty was exacerbated by the fact that there was less money to be lent. A larger deposit was now needed to buy a home. In addition, there was also uncertainty about future prospects for employment. Therefore, there were suddenly less generous terms for mortgages with higher rates, higher deposits and some severe changes to the fee structure.
Mortgage characteristics changed to a tougher degree with less choice. There were now shorter terms, no 100% LTV and there was a halt to interest only products. There was also a change in loan to income ratios as lenders reduced the risks associated with mortgage repayments that were more than three times the borrower’s annual income. The types of loans on offer changed back to those of former years with a return to more traditional products. Additionally, the once ubiquitous buy-to-let mortgage was now a thing of the past or at least it became a high deposit, high interest rate product that was only available to really low risk borrowers.
There were some new innovative products that were designed to help the flow of new customers. These included a product for first a time buyer that was a 95% LTV for a property. If, after 5 years the value of the property had fallen then the developer promised to give back up to 15% of the drop in price. There were also some tracker mortgages which, in fact, turned out to be a good deal since the Bank of England interest rate has remained consistently low since 2009.
More Thorough Underwriting Practices
Other changes to lending policy were reflected in a demand for better credit scores and a further demand that potential borrowers have a decent loan to income ratio that was proved by payslips or P60s. Other responses to the lending policy were made by the government who wanted some lending to continue so that the housing market did not grind to a halt. It was a difficult path that the government trod by trying to encourage some lending. On the other hand, only responsible lending to creditworthy borrowers.
By creating the Financial Conduct Authority, the government made control of lending a part of the regulators remit. They did not just leave it to the banks which had proved to be spectacularly inefficient. There was a code of conduct put in place regarding mortgage arrears. In this way people who were in financial difficulties had a period of time to try to sort themselves out without the threat of losing their home. Other countries such as Iceland and Greece simply put a stop to foreclosures for the foreseeable future.
The Mortgage Rescue Scheme
In England there was a mortgage rescue scheme that was started in 2009. It was set up to help 6000 householders who found themselves in trouble with arrears. This was a priority scheme that was aimed at protecting households with small children or vulnerable people such as the disabled or the elderly. However, the take up of the scheme was not great.
Regulators have now taken a stronger line with banks to ensure more stringent tests before mortgages are granted. And, while lenders have become much more conservative with their lending policy since 2008, the FCA is determined that there will never be a return to the risky lending that occurred before the credit crunch.
Since 2010 there have been rules put in place regarding interest only mortgages which can only be for 25 years. They can only be taken on if the borrower can afford to have a realistic method of paying it back. i.e an endowment insurance or annuity policy. Finally, there has also been a change in the way that borrowers are treated. The FCA now demands that any potential borrower fully understands the risks involved with taking on a large debt like a mortgage. The rationale behind this move has forced lenders to stop offering risky products and to be more open and transparent with borrowers about costs and risks if repayments are not made on time. The long term results of these changes are not yet known as at the present time the housing market is still not fully recovered.