Lenders prepared to manage higher mortgage interest rates and increased default levels

Lenders have never been in a stronger position to manage higher mortgage interest rates and increased default levels.

Many mortgage holders have been eagerly awaiting the next Bank of England rate cut in the expectation that it will lead to significantly lower monthly mortgage payments for them.

Unfortunately, they are largely wasting their time. Truth is that mortgage rates for most are not going to come down substantially any time soon. And we will to have to wait a long time for them to return to the rock bottom rates that the UK had become used to.

There may well be 0.25% incremental cuts over the next couple of years in the Bank Base Rate, but the days of low-rate fixes – especially those of 2%-and-lower variety – are gone. At least for the time being.

Households with mortgages up for renewal in the UK will face significantly higher payments until 2026 at the earliest because of the nationally and internationally tightening credit market. The majority of mortgages up for renewal at the present time have effective mortgage rates of less than 2.5 percent, way below what is now available. As a result, about two million mortgage loans are projected to experience a monthly cliff-edge payment increase by 2026 of hundreds of pounds. And, for a further 2.7 million mortgages with longer periods left on their fixes, monthly costs could soar even higher.

Unless you are on a tracker – which most are not given that 74% of mortgages in the UK are fixed – changes to the Bank Base Rate are going to make little or no difference.

Government and personal indebtedness has reached historically high levels and creditors want higher returns given the greater supposed risk exposure. This is not going to change overnight, especially with a Labour government now in power. Ten-year government gilts that were trading at under 0.5% four years ago, are now priced at over 4%, higher than even under the brief Truss era.

The uncomfortable fact is that borrowing is now more expensive. Home owners will have to dial in a larger chunk of disposable income for their mortgage direct debits, and lenders are going to have to get used to higher costs of funding from wholesale and retail markets plus increased risk.

The last time the mortgage market had a crunching of gears this dramatic was back in October 1989 when rates doubled to 14.88%. Since that time we have all got used to interest rates being stable and low: drifting from 5% to 0.5% in 2009, to remain there until the end of Covid.

The mortgage market has moved into a new phase. And, alongside the higher rates, there are cost of living rises and heightened regulatory oversight in the form of Consumer Duty and vulnerability to consider. The challenge to personal and commercial finances is considerable. Affordability is going to limit borrowing and default rates, which have been rising, will continue to do so.

Thankfully, unlike the last significant gear change, we now have a completely different decisioning ecosystem underpinned by Fintech that, if used correctly, will minimize the costs of transition for both the lender and borrower.

Plug-and-play auto-assisted underwriting platforms using CRA, a range of third-party data sources and Open Banking, such as LendingMetrics’ ADP, are really going to come into their own by allowing lenders to precisely calibrate lending provision to market conditions on an hour-by-hour basis. Scaling up or down the risk spectrum is only ever a few clicks away.

As is taking a granular view of every applicant to get real-time insight into their lending suitability. Unwise borrowing is much easier to detect.

Additionally, machine learning makes this already smart decisioning even smarter over time. Our own DataOrchestrator, for example, allows users to interrogate data they receive from third parties in a way that is optimal for whatever environment they find themselves in. Whenever a package of data arrives, the lender creates bespoke characteristics via a straightforward editor interface. The lender can finesse sets of predictive questions over time and across multiple data inputs to decision against.

Notably, this is the first period of higher interest rates that lenders have the tools to make sophisticated assessments. And obviously they will only be made on new business cases. Historic lending based on more analogue technology will remain and present a higher default risk profile.

However, even here, the technology makes loan book management a far more exact science. Lenders can tap into data feeds that can pre-warn underwriters when borrowers are on course to miss payments. A single pre-emptive telephone call while the borrower is still able to meet their commitments can be used to reschedule a loan, rather than the usual situation of having calls ignored after they fall into arrears.

Lenders now have access to data and analysis that will guide them to making optimal decisions,  from both the lender’s and borrower’s perspective. Decisions that they would only have been able to dream about twenty years ago.

David Wylie is the Commercial Director of LendingMetrics