The mortgage loans industry and market
There are currently over 200 significant separate financial organizations supplying mortgage loans to house buyers in Britain. The major lenders include building societies, banks, specialized mortgage corporations, insurance companies, and pension funds. Over the years, the share of the new mortgage loans market held by building societies has declined. Between 1977 and 1987, it fell drastically from 96% to 66% while that of banks and other institutions rose from 3% to 36%. The banks and other institutions that made major inroads into the mortgage market during this period were helped by such factors as:
- relative managerial efficiency;
- advanced technology, organizational capabilities, and expertise in marketing;
- extensive branch networks; and
- capacities to tap cheaper international sources of funds for lending.[3]
By the early 1990s, UK building societies had succeeded in greatly slowing if not reversing the decline in their market share. In 1990, the societies held over 60% of all mortgage loans but took over 75% of the new mortgage market – mainly at the expense of specialized mortgage loans corporations. Building societies also increased their share of the personal savings deposits market in the early 1990s at the expense of the banks – attracting 51% of this market in 1990 compared with 42% in 1989.[4] One study found that in the five years 1987-1992, the building societies collectively outperformed the UK clearing banks on practically all the major growth and performance measures. The societies' share of the new mortgage loans market of 75% in 1990-91 was similar to the share level achieved in 1985. Profitability as measured by return on capital was 17.8% for the top 20 societies in 1991, compared with only 8.5% for the big four banks. Finally, bad debt provisions relative to advances were only 0.4% for the top 20 societies compared with 2.8% for the four banks.[5]
Though the building societies did subsequently recover a significant amount of the mortgage lending business lost to the banks, they still only had about two-thirds of the total market at the end of the 1980s. However, banks and building societies were by now becoming increasingly similar in terms of their structures and functions. When the Abbey National building society converted into a bank in 1989, this could be regarded either as a major diversification of a building society into retail banking – or as significantly increasing the presence of banks in the residential mortgage loans market. Research organization Industrial Systems Research has observed that trends towards the increased integration of the financial services sector have made comparison and analysis of the market shares of different types of institution increasingly problematical. It identifies as major factors making for consistently higher levels of growth and performance on the part of some mortgage lenders in the UK over the years:
- the introduction of new technologies, mergers, structural reorganization and the realization of economies of scale, and generally increased efficiency in production and marketing operations – insofar as these things enable lenders to reduce their costs and offer more price-competitive and innovative loans and savings products;
- buoyant retail savings receipts, and reduced reliance on relatively expensive wholesale markets for funds (especially when interest rates generally are being maintained at high levels internationally);
- lower levels of arrears, possessions, bad debts, and provisioning than competitors;
- increased flexibility and earnings from secondary sources and activities as a result of political-legal deregulation; and
- being specialized or concentrating on traditional core, relatively profitable mortgage lending and savings deposit operations.[6]
Mortgage types
The UK mortgage market is one of the most innovative and competitive in the world. Unlike some other countries, there is little intervention in the market by the state or state funded entities and virtually all borrowing is funded by either mutual organisations (building societies and credit unions) or proprietary lenders (typically banks). Since 1982, when the market was substantially deregulated, there has been substantial innovation and diversification of strategies employed by lenders to attract borrowers. This has led to a wide range of mortgage types.
As lenders derive their funds either from the money markets or from deposits, most mortgages revert to a variable rate, either the lender's standard variable rate or a tracker rate, which will tend to be linked to the underlying Bank of England (BoE) repo rate (or sometimes LIBOR). Initially they will tend to offer an incentive deal to attract new borrowers. This may be:
- A fixed rate; where the interest rate remains constant for a set period; typically for 2, 3, 4, 5 or 10 years. Longer term fixed rates (over 5 years) whilst available, tend to be more expensive and/or have more onerous early repayment charges and are therefore less popular than shorter term fixed rates.
- A capped rate; where similar to a fixed rate, the interest rate cannot rise above the cap but can vary beneath the cap. Sometimes there is a collar associated with this type of rate which imposes a minimum rate. Capped rate are often offered over periods similar to fixed rates, e.g. 2, 3, 4 or 5 years.
- A discount rate; where there is set margin reduction in the standard variable rate (e.g. a 2% discount) for a set period; typically 1 to 5 years. Sometimes the discount is expressed as a margin over the base rate (e.g. BoE base rate plus 0.5% for 2 years) and sometimes the rate is stepped (e.g. 3% in year 1, 2% in year 2, 1% in year three).
- A cashback mortgage; where a lump sum is provided (typically) as a percentage of the advance e.g. 5% of the loan.
To make matters more confusing these rates are often combined: For example, 4.5% 2 year fixed then a 3 year tracker at BoE rate plus 0.89%.
With each incentive the lender may be offering a rate at less than the market cost of the borrowing. Therefore, they typically impose a penalty if the borrower repays the loan within the incentive period or a longer period (referred to as an extended tie-in). These penalties used to be called a redemption penalty or tie-in, however since the onset of Financial Services Authority regulation they are referred to as an early repayment charge.
Self Cert Mortgage
Mortgage lenders usually use salaries declared on wage slips to work out a borrower's annual income and will usually lend up to a fixed multiple of the borrower's annual income. Self Certification Mortgages, informally known as "self cert" mortgages, are available to employed and self employed people who have a deposit to buy a house but lack the sufficient documentation to prove their income.
This type of mortgage can be beneficial to people whose income comes from multiple sources, whose salary consists largely or exclusively of commissions or bonuses, or whose accounts may not show a true reflection of their earnings. Self cert mortgages have two disadvantages: the interest rates charged are usually higher than for normal mortgages and the loan to value ratio is usually lower.
100% Mortgages
Normally when a bank lends a customer money they want to protect their money as much as possible; they do this by asking the borrower to fund a certain percentage of the property purchase in the form of a deposit.
100% mortgages are mortgages that require no deposit (100% loan to value). These are sometimes offered to first time buyers, but almost always carry a higher interest rate on the loan.
Together/Plus Mortgages
A development of the theme of 100% mortgages is represented by Together/Plus type mortgages, which have been launched by a number of lenders in recent years.
Together/Plus Mortgages represent loans of 100% or more of the property value - typically up to a maximum of 125%. Such loans are normally (but not universally) structured as a package of a 95% mortgage and an unsecured loan of up to 30% of the property value. This structure is mandated by lenders' capital requirements which require additional capital for loans of 100% or more of the property value.
UK mortgage process
UK lenders usually charge a valuation fee, which pays for a chartered surveyor to visit the property and ensure it is worth enough to cover the mortgage amount. This is not a full survey so it may not identify all the defects that a house buyer needs to know about. Also, it does not usually form a contract between the surveyor and the buyer, so the buyer has no right to sue if the survey fails to detect a major problem. For an extra fee, the surveyor can usually carry out a building survey or a (cheaper) "homebuyers survey" at the same time.[7]
Mortgage insurance
Mortgage insurance is an insurance policy designed to protect the mortgagee (lender) from any default by the mortgagor (borrower). It is used commonly in loans with a loan-to-value ratio over 80%, and employed in the event of foreclosure and repossession.
This policy is typically paid for by the borrower as a component to final nominal (note) rate, or in one lump sum up front, or as a separate and itemized component of monthly mortgage payment. In the last case, mortgage insurance can be dropped when the lender informs the borrower, or its subsequent assigns, that the property has appreciated, the loan has been paid down, or any combination of both to relegate the loan-to-value under 80%.
In the event of repossession, banks, investors, etc. must resort to selling the property to recoup their original investment (the money lent), and are able to dispose of hard assets (such as real estate) more quickly by reductions in price. Therefore, the mortgage insurance acts as a hedge should the repossessing authority recover less than full and fair market value for any hard asset.
Islamic mortgages
The Sharia law of Islam prohibits the payment or receipt of interest, which means that practising Muslims cannot use conventional mortgages. However, real estate is far too expensive for most people to buy outright using cash: Islamic mortgages solve this problem by having the property change hands twice. In one variation, the bank will buy the house outright and then act as a landlord. The homebuyer, in addition to paying rent, will pay a contribution towards the purchase of the property. When the last payment is made, the property changes hands.[citation needed]
Typically, this may lead to a higher final price for the buyers. This is because in some countries (such as the United Kingdom and India) there is a Stamp Duty which is a tax charged by the government on a change of ownership. Because ownership changes twice in an Islamic mortgage, a stamp tax may be charged twice. Many other jurisdictions have similar transaction taxes on change of ownership which may be levied. In the United Kingdom, the dual application of Stamp Duty in such transactions was removed in the Finance Act 2003 in order to facilitate Islamic mortgages.[8]
An alternative scheme involves the bank reselling the property according to an installment plan, at a price higher than the original price.
All of these methods are still compensating the lender as if they were charging interest, but the loans are structured in a way that in name they are not, but they share the financial risks involved in the transaction with the homebuyer.[citation needed]
Other terminologies
Like any other legal system, the mortgage business sometimes uses confusing jargon. Below are some terms explained in brief. If a term is not explained here it may be related to the legal mortgage rather than to the loan.
Advance This is the money you have borrowed plus all the additional fees.
Base rate In UK, this is the base interest rate set by the Bank of England. In the United States, this value is set by the Federal Reserve and is known as the Discount Rate.
Bridging loan This is a temporary loan that enables the borrower to purchase a new property before the borrower is able to sell another current property.
Disbursements These are all the fees of the solicitors and governments, such as stamp duty, land registry, search fees, etc.
Early redemption charge / Pre-payment penalty / Redemption penalty This is the amount of money due if the mortgage is paid in full before the time finished.
equity This is the market value of the property minus all loans outstanding on it.
First time buyer This is the term given to a person buying property for the first time.
Loan origination fee A charge levied by a creditor for underwriting a loan. The fee often is expressed in points. A point is 1 percent of the loan amount.
Sealing fee This is a fee made when the lender releases the legal charge over the property.
Subject to contract This is an agreement between seller and buyer before the actual contract is made.
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