It’s been a very big month for the retirement lending industry with two major announcements coming in a very short space of time.
These announcements have the ability to change the market for the better and fire the starting gun for what is hopefully going to be a long race of innovation.
Firstly, the Financial Conduct Authority (FCA) has seen sense and removed the requirement for advisers and lenders to assess affordability on lifetime mortgages that provide the ability to repay a regular set amount.
Making doubly sure that the mortgage customer is able to afford their financial commitments was the cornerstone of the Mortgage Market Review.
However, before this review came about and affordability criteria was heavily tightened, a range of hybrid lifetime mortgage products had been invented.
These ‘hybrid’ products were so named because they allowed the customer to set-up monthly repayments, to offset some or all of the compound effects of not making any repayments to a lifetime mortgage and letting the interest ‘roll-up’.
The innovative feature is that if the customer no longer wishes to pay, or can no longer afford to pay, then the mortgage repayments will stop. This effectively converts the plan into a regular interest roll-up lifetime mortgage.
Having strict affordability criteria effectively rendered these hybrid lifetime mortgages to the scrap heap.
Instead, customers opted for plans where they could make ad hoc, flexible repayments. These don’t carry with them the same level of commitment from the outset, which suited lots of customers – especially those used to ‘setting and forgetting’ their mortgage direct debit.
Obviously, the key area lenders use affordability is to assess whether the customer will get into trouble and face default and possible repossession. With the clever ability of these products to switch to roll-up, these were concerns that were never going to arise.
Although these products have been widely available since MMR, in practice they were rarely sold nor bought, as the flexible repayment plans provided 9/10th of the functionality without the affordability hurdles.
So, this decision by the FCA is wholeheartedly welcomed as it brings these highly innovative products back to the market.
It means we’re going to see an influx of new hybrid lifetime mortgages coming to market without the burden that affordability unnecessarily brings.
We believe we will start to see the range of traditional mortgages emulated but with a lifetime term, inbuilt flexibility and the backstop of rolled-up interest to ensure that if a customer is unable to continue payments, they don’t face repossession.
There will, of course, be slightly higher margins in the interest rates to offset the longer-term return on investment and the cash-flow impact this has on lenders. After all, optional repayments can’t be relied upon when modelling the mortgage book.
This prophecy is already holding true with the launch of the OneFamily lifetime mortgage – the second major announcement that has shaken up the retirement lending world.
The lifetime mortgage and traditional mortgage sector are converging with the announcement that they will be launching with a variable interest rate plan.
The interest rate margin is set at the outset of the plan, and the variance comes from the Consumer Prices Index. Given where inflation is currently, we expect this plan to be hugely popular with customers.
We also expect it to open the floodgates for other variable rate plans with other benchmarks such as LIBOR.
Many customers will opt for the certainty that a lifetime fixed rate provides though given the recent low-interest, low-inflation environment, you can sense the temptation to take a risk today on a variable rate.
The sources of, and relative difficulty in setting up, funding for lifetime mortgages will always require a longer-term view on the term of these mortgages, so we don’t expect to see a market where customers are switching and shopping after three to five years a la the traditional mortgage world.
Ultimate flexibility is still a long way off and there are inherent challenges in providing this. A flexible, lifetime term naturally restricts some of the flexibility offered in mortgage products with a shorter life expectancy.
What’s great news for the industry is that more choice is coming into the market, the products are starting to look very similar to what the customers are used to buying, and the FCA has decided to foster innovation rather than stunt it.
Watch this space, it’s going to develop rapidly.
Steve Wilkie is managing director at Responsible Equity Release