James Tatch, Principal, Analytics, UK Finance
A potted history
Since 2013, when the then FSA conducted its first thematic review into interest-only mortgages, the industry has looked to take the front foot in tackling any potential repayment issues that interest-only customers might encounter as their loans reach maturity. In 2015 lenders fulfilled an industry-wide commitment to contact all interest-only borrowers with loans scheduled to mature before the end of 2020, to ensure they were on track to repay their loans and, where there looked to be problems, work with borrowers to rectify the situation.
We also developed an interest-only toolkit – a framework which lenders can use to develop their strategies to engage with and help customers over the life of their interest-only borrowing, to ensure they have the means to repay their loan.
Alongside this pro-active engagement and policy work we also began collecting detailed industry data on the size and profile of the interest-only back book, on lenders’ ongoing customer engagement programmes and finally, on what happens in the cases where the borrower does not meet the “bullet payment” on the date of maturity. This management information piece is crucial to the industry’s ability to effectively monitor and react to the evolution of loans in the interest-only back book, a sentiment echoed in the FSA’s published guidance in 2013.
When we first sized the interest-only mortgage stock in 2012, there were some 3.2 million interest-only loans outstanding (including both pure interest-only and part-and-part mortgages – those which are part interest-only and part repayment), equivalent to a third of all homeowner mortgages. Whilst the FSA did not find widespread problems in the treatment of interest-only customers, the size of the book itself presented perhaps the largest concern.
Since then the industry’s ongoing pro-active approach, which the FCA itself held up as “a prime example of a model demonstrating good conduct outcomes and putting customers first,” has helped change the tone of the conversation, with evidence of ongoing positive progress.
A glass half full
Today we publish figures showing the interest-only book now stands at 1.7 million mortgages, worth £250 billion. This is a little over half the number it was just six years ago.
This smaller interest-only book is also far healthier, in terms of the equity position of borrowers. In 2012 over 900,000 pure interest-only mortgages – 36% of the total – had an LTV of 75% or greater. Last year this had fallen to just 174,000 mortgages, or 13% of the total.
The FSA’s 2013 thematic identified three distinct tranches of interest only maturities, 2012-2020, 2021-2027 and 2028-2033. As we approach the end-point of this first tranche it’s very positive news that, of the one million loans due to mature by 2020 that were live at the end of 2012, only around 200,000 now remain. Some 600,000 of these had maturity dates on or before 2017, so are, effectively, successful redemptions on schedule. But the remainder – around 200,000 mortgages – had redeemed ahead of schedule. The vast majority of these have converted their mortgage onto repayment terms, either internally or with another lender, with smaller numbers redeeming fully and finally before the end of term.
Is the industry approach working?
Our data on customer contacts and outcomes gives some context around the extent to which lender engagement may be helping.
Making successful contact with your customer base is a challenge in many industries, but perhaps few more so than in financial services. Borrowers, particularly those less financially capable or under financial strain, may be more reluctant to engage. Alongside our monitoring exercises, the industry has come together to share what works and what doesn’t, including best practice, to develop the best targeted strategies, and maximise customer engagement.
Collecting robust data on these strategies is difficult. This is not least because, as strategies build on new learning and evolve, the data that a lender provides in one year naturally evolves to inform the strategy. These factors have meant that we do not have robust contact figures for 2017, however we are able to compare and contrast trends for a smaller sample of borrowers for whom we have data across periods.
From this data, it appears the industry’s collaborative approach has reaped rewards. In 2014, when these contact programmes first began as a coordinated industry initiative (although many lenders were already operating their own programmes ahead of this), responses rates were around 16 per cent for contacts to borrowers with pre-2020 maturities, and ten per cent overall. Four years later, the data suggest the industry has built on best practice, such that contacts response rates have approximately doubled for near-term maturities, and trebled overall. Whilst there is still plenty of room for improvement, the industry is making really good progress in engaging successfully with more and more borrowers.
Most borrowers have plans in place
Where the contact is successful, more than four in five borrowers advised they had a repayment strategy in place. Amongst the most imminent (up to 2020) maturities, this rises even further – around six out of seven have plans in place.
Whilst these are good figures, a more important one is the small minority where the borrower does not have a repayment strategy, particularly where the mortgage is approaching term. It’s then a further positive message from the data that better than one in ten successful contacts amongst these near maturities resulted in a change of contractual terms, most commonly a switch to repayment or a term extension.
Overall then, the data show improvement in several areas. There are continuing redemptions of interest-only mortgages, both on and ahead of schedule, to reduce the size of the remaining book much faster maturity profile has suggested. There are material reductions in numbers of interest-only mortgages at higher LTVs, so that fewer of those remaining interest-only borrowers are constrained in their options by insufficient equity. And lenders are seeing more success in engaging with their interest-only customer base to assess repayment plans and, in cases where there are none, put viable plans in place.
However, despite these continuing improvements, the third section of our monitoring data shows that, each year, there is a small but crucially important number of interest-only mortgages that do not redeem in full on their maturity date. Last year there were 34,000 such “term-expired” mortgages.
The evidence continues to show that the vast majority of these mortgages do subsequently redeem post-term within a “grace period” without the need for any formal intervention. Although the data constantly evolve we are seeing that, over time, about 90 per cent of term-expired mortgages do redeem post-term in this way. And in fact, the time frame for doing so is typically very short – two thirds of these post-term redemptions happen within three months after the maturity date.
For the minority of cases where the borrower cannot redeem in this way, lenders work through a range of options to allow the borrower to repay the loan. Formal term extensions for a fixed, usually relatively short period, are more common in the first year or two. For term-expired mortgages that persist for longer without redeeming, increasing numbers are switched to repayment terms and progressively pay off the loan that way. A number of customers also sell their properties to pay the capital.
However, there are a very small number of cases when, after all options have been exhausted, the borrower has no realistic chance of repaying the loan. The incidence of repossession amongst term-expired interest-only loans is very low indeed, even in the context of the current benign environment where mortgage possessions overall are near 40-year lows.
Since 2011 the cumulative repossession rate over those seven years for term-expired interest-only mortgages is 0.4 per cent, a tiny fraction of a section of loans that, technically, are all in default. Although direct comparisons with the wider market are not that meaningful, it is nonetheless a sign of the efforts the industry has made to help interest-only customers manage out their loans that this cumulative rate is around a third of that wider market experience.
Hitting a shrinking target
Since we began collecting detailed data on interest-only it hasn’t been hard to show positive results, because these trends of a shrinking, improving book have continued year on year. But in doing so it’s crucial that the industry doesn’t lose sight of the less positive facts – the small and shrinking cohorts of interest-only borrowers remaining, particularly those at higher LTVs and/or the nearer end of the maturity spectrum. Further, the challenge of getting borrowers to engage on this issue isn’t getting easier, even though lenders are seeing more success. In fact, this increased success brings additional challenge in that, increasingly, borrowers who have not responded yet are likely to be equally reluctant to do so with further attempts. So, the industry faces an ever-present challenge to find better ways to engage with reluctant borrowers.
For those of us that remember it, we could think of this challenge as being like Space Invaders: at the start of the game there are plenty of targets, albeit that most are far away. It’s relatively easy at that point to fire and hit quite a few targets, particularly the nearest ones, even if your aim isn’t that good. As the round progresses, more and more of the simpler targets are eliminated successfully, leaving the faster-moving, more elusive ones. So, you need to improve your aim, and make your strategy more agile, to pick off the shrinking numbers ahead of you.
It’s very positive news that, like the initial thematic in 2013, the FCAs follow-up work last year found very few problems amongst lenders’ treatment of interest-only borrowers. It did, however, focus on engaging with those borrowers who up until now have been reluctant to engage and urging borrowers who may have difficulty in making final repayment to talk to their lender and discuss options. We very much welcome and echo this message. For the industry, UK Finance is reviewing and updating our interest-only toolkit to encompass the learning of the past few years and react to the changing regulatory landscape (for example, allowance for Retirement Interest-only mortgages with no fixed end date). In this way, innovating and learning, the industry can continue to improve on its successes to date.