Loans Articles

If you’re one of the millions of people in the UK who have a mortgage on their home, or have some other type of loan secured against their property, then you’re probably a little concerned about the current economic dilemma which is gripping the UK lending market. Either that or you’re one of the many people who are completely sick and tired of hearing about the “Credit Crunch” and the state of the British economy every time you open a Newspaper or switch on the evening news on the television. If you fall into the latter category (and you’ve still managed to read this far!) I apologise for going on about it even more, but it’s probably worth taking an overview of the situation and look at the possible implications for borrowing, both now and in the future.

The current problems faced by many of the high street banks and other lending institutions have in fact been brewing for some time and many observers of the financial markets have predicted a slowdown in the economy and possibly even a recession and claim that this is now actually long overdue. The economy has actually been gradually slowing down over the past few years, but has been propped up by an increasing housing market which has grown dramatically over the same period to an excessive level. We, as a nation have been encouraged to borrow our way out of any potential recession, using the increased levels of equity within our homes and other properties to secure loans and other credit commitments which we perhaps would not have taken on if our homes had not been growing in value so well. Lenders have also taken a very relaxed view with regard to lending criteria over recent years, with high income multiples being used to calculate maximum loans (multiples of up to ten times salary have not been unknown), high loan to value ratios (in some cases up to 125% loan to value) and relaxed underwriting of loans and mortgages with things such as self certification of income, where an individual has not been required to provide any proof of income to a lender before acquiring a loan and also sub prime lending, where those individuals with a poor credit history through defaults on their payments and county court judgements, have still been able to obtain finance.

This irresponsible lending by the banks and other major financial institutions has finally caught up with them, although those individuals who borrowed all the money in the first place are not entirely blameless. Many individuals borrowed at a far higher level than they could realistically afford in the long term, often on a low, fixed rate of interest for a short initial period such as two or three years. Now many of these loans and mortgages are reaching the end of their fixed rate period and the interest charged is about to increase dramatically, in many cases to an unaffordable level. As lenders have been forced to withdraw products and restrict lending criteria to a sensible level, (where, realistically they should have always remained) many borrowers whose fixed rate deals on their mortgages and other secured loans are about to end are likely to find themselves unable to meet the monthly repayments and also unable to remortgage or restructure their loans. Recent figures released by the Council of Mortgage Lenders indicate that approximately 1.4 million people in the UK will be coming to the end of a cheap, fixed rate deal this year and many of these will be facing increased payments of anything between 30 and 60 percent. This will inevitably lead to increased levels of arrears and repossessions, which will hit many lenders who are already struggling, very hard indeed.

Many lenders have severely restricted their lending criteria by reducing income multiples to more manageable levels and reducing the maximum loan to value ratio they offer, in some cases, to as low as 75%, whilst increasing the interest rates they charge, particularly on the sub-prime sector of the market. Even these restrictions have not been sufficient for some lenders, and many lending companies, particularly those who have been largely exposed to the sub-prime sector, have been forced to withdraw from new lending business altogether, whilst others have had to downsize dramatically, making large numbers of their staff redundant. Although the Bank of England base rate is steadily reducing, the rate at which financial institutions borrow from each other, LIBOR (London Inter Bank Offered Rate), remains particularly high, which means that lenders are unable to borrow funds on the wholesale money market in order to fund their own products. Just last week, the Royal Bank of Scotland became the first high street bank to launch a rights issue in order to raise approximately £10m from its share holders to rebuild their capital reserves. This was closely followed by the Halifax Bank of Scotland group and doubtless there will be many more lenders who will be forced to follow this trend.

So is it all doom and gloom? Are we about to face a crash in the property market similar to the one in the early nineties? Is the economy on a downward spiral to recession, or is there light at the end of the tunnel? The media are always quick to pounce on bad news, often exacerbating the situation. The Bank of England has announced a plan to relieve some of the pressure on lenders and try to improve the liquidity of the banking sector and raise the level of confidence in the financial markets by allowing lenders to swap mortgage backed securities for £50bn of Treasury bills.  Although this will only go part way to alleviate the funding problem, it will hopefully help to restore confidence within lending organisations, even though any losses they have made on loans will remain the responsibility of the banks themselves.

As for the housing market, it seems unlikely that we will be faced with the same situation that many of us still remember from the early nineties, when house prices plummeted leaving many homeowners with negative equity in their homes and paying interest rates on their mortgages of up to 15%, which led to hundreds of repossessions. Although the latest figures from the Halifax and Nationwide both show a fall in house prices of 1% over the past twelve months, this reduction is lower than many predicted and speculation as to the short term (i.e. next twelve to eighteen months) future of property prices is divided, with some saying that there will be a reduction of at least 10% over the next year, whilst others state that demand is still greater than supply for housing and therefore prices will remain high. Interest rates are significantly lower than the early nineties, with the Bank of England base rate currently 5% and likely to reduce further over the next twelve months, which means that the cost of borrowing money on a mortgage or loan is comparatively cheap. Gross lending on mortgages for March 2008 was £26.3bn according to the Council of mortgage Lenders, which was an increase of 5% over February 2008, but down by 17% from £31.7bn at the same time last year. This could be caused by people not being able to obtain funding for their mortgage, or more likely being cautious and waiting to see what happens with prices in the next few months. Either way, a slight reduction in house prices could be a good thing for the housing market and coupled with low interest rates, could be just enough to encourage individuals to enter the property market once more. Yes, there have been casualties as a result of the Credit Crunch and it is likely that there will be more before we come out of the other side, but one thing’s for sure, it’s going to be an interesting year!