New warnings over mortgage imprisonment as lenders tighten borrowing

More and more homeowners are at risk of becoming mortgage “prisoners”, financial advisers have warned, as lenders seek to protect themselves from the risk of lending defaults amid the cost of living crisis.

High street names have been warning for some time that affordability calculations would have to change because of the altered economic circumstances we now find ourselves in. Many have already made changes, and others are preparing to do so.

Today, high street bank Santander will become the latest to change the way it calculates how much or even if a mortgage applicant can borrow based on their personal circumstances.

This will include factoring in the rising cost of living and tax rises as well as increasing the “stress test” interest rate, used to check if applicants could absorb a rise in interest rates.

Stronger rules around mortgage affordability criteria were introduced in 2014 in the wake of the financial crisis in a bid to help prevent consumers borrowing more than they could afford to repay.

Where lenders once based their decisions on little more than a multiple of the applicant’s income, they now have to take into consideration personal circumstances, typical outgoings like childcare and debt repayments, credit ratings and overall indebtedness.

These figures are used to determine how much an applicant can comfortably afford to consistently repay under their current circumstances, but also to test whether their financial circumstances could withstand changes like interest rate rises.

Because mortgages are long-term commitments, with two, five and even ten-year agreements increasingly common, lending criteria can and do alter over time.

Even if their circumstances don’t change, someone who had been consistently repaying their mortgage over several years could find themselves unable to secure a new arrangement when their deal ends. This means defaulting to their current lender’s standard variable rate (SVR) – usually far more expensive than their previous deal.

In fact, these so-called mortgage prisoners often find themselves in the bizarre position of paying more for their mortgage after lenders decided they wouldn’t be able to afford a cheaper deal.

In March, just before the last base interest rate hike to 0.75 per cent, the average SVR was 4.61 per cent, for example, compared with 2.03 per cent for the average two-year tracker, according to analysis of data from Moneyfacts.

But how big a problem is all this?

Back in November the Financial Conduct Authority (FCA), the UK’s financial regulator, launched a review into the problem and calculated there were 47,000 mortgage prisoners unable to switch to a new mortgage deal despite being up to date with payments.

But that was months before the latest rises in interest rates, and the soaring cost of living had yet to deliver its sucker punches – including this week’s rise in National Insurance contributions, last week’s 54 per cent rise in the energy price cap and the ongoing inflationary effects of the invasion of Ukraine.

Those figures also don’t take into account thousands of people whose properties have been sold for less than their outstanding mortgage, leaving them with a payment shortfall, for example.

Nor do they factor in “the estimated 1.93 million people who have become mortgage prisoners in England, rejected by lenders when trying to remortgage and unable to sell their homes because of the cladding crisis following the Grenfell disaster”, notes Myron Jobson, senior personal finance analyst for interactive investor, an investment platform.

Graham Cox, founder and director of the Self Employed Mortgage Hub, is particularly concerned for the UK’s 5 million self-employed people.

“The stamp duty holiday, exceptionally low mortgage rates, housing stock shortages and the ‘race for space’ have driven up house prices to absurd heights”, he says.

“But… lenders’ affordability criteria are already tightening. When the time comes to remortgage, it’s possible overstretched business owners could be left stranded on unaffordable SVR rates. It depends on whether their existing lender is willing to provide a new deal.

“Nonetheless, if house prices go into sharp reverse, which is a distinct possibility, we’re looking at negative equity, repossessions, and a whole world of pain.”

The FCA review of mortgage imprisonment could lead to changes, however, including the relaxation of some calculations.

“While it is widely accepted that the updated ONS data feeding into lenders’ affordability models should see the amount they offer to lend fall, there is a potential knight in shining armour coming to the rescue in the form of the regulator”, says Scott Taylor-Barr, financial adviser at Carl Summers Financial Services.

“One of the controls the regulator placed on lenders following the global financial crisis and credit crunch was enforcing the rate at which these affordability models were stress testing applicants on shorter term deals; typically at around 5.5-6.99 per cent (the lender’s standard variable rate, or the deal’s follow-on rate +3 per cent), but there is talk of this enforced rate being removed.

“Lenders will still be expected to lend responsibly, but this does give them a little more flexibility – flexibility that some of them may use to help mitigate the impact of rising costs on their affordability calculators.”