There is a growing number of homeowners, dubbed “mortgage prisoners”, who are trapped with their current mortgage (and mortgage provider) because they are unable to switch to a new mortgage.
How do you become a mortgage prisoner?
This is particularly problematic if you’ve got a large mortgage, you’ve exhausted the low-interest promotional period on your mortgage, and you find yourself stuck on the mortgage lender’s high-interest SVR (standard variable rate).
For example, if you owe £400,000 and still have 20 years to go on your mortgage, and you’re stuck on your lender’s SVR at 4%, your monthly repayments would be a hefty £2,400. That’s almost £500 more per month than a fixed-rate mortgage with a market-leading interest rate.
Mortgage prisoners: Spawned by the global financial crisis
The first big wave of mortgage prisoners arrived after the 2008 global financial crisis. For a few years leading up to the crisis, banks were prepared to lend much more money and accept smaller deposits.
Prior to the 1996 to 2008 property price boom, the maximum amount you could borrow was about four times your salary and you needed a deposit of around 10%. The average price of a UK home back then was only £51,000 – about 3.5 times the average UK salary.
In the early 2000s, 100% LTV mortgages (i.e. no deposit) were unexceptional, self-employed workers could self-certify their income, and banks were prepared to lend up to eight times your annual salary.
As a result, many people borrowed heavily – and with house prices rising much faster than salary growth, the ratio between earnings and home values quickly grew. By 2006 the average house price was up to £160,000 – but the average income had only risen to £20,400.
Following the financial crisis, the UK’s financial regulator ordered a review of mortgage lending rules, which led to much stricter lending criteria. Then, when borrowers who had borrowed heavily tried to negotiate a new mortgage deal, lenders turned them down because they couldn’t fulfil the new lending criteria. It wasn’t called the credit crunch for nothing!
These mortgage prisoners were forced to keep their current mortgage and pay the lender’s SVR, which can be anywhere from 2% to 5% higher than the interest rate on a market-leading mortgage. Meanwhile, the Bank of England dramatically cut the base interest rate to 0.5%, leading to some incredibly cheap mortgages for borrowers who still qualified.
Beyond that, there were two other factors during the financial crisis that led to the creation of mortgage prisoners. Many borrowers with interest-only mortgages had little or no equity in their property when the mortgage lending rules were tightened. And customers who were with lenders who collapsed during the crisis – like Northern Rock or Bradford & Bingley – had their mortgages sold off to investors who don’t offer mortgages, so they couldn’t get an alternative deal.
What creates mortgage prisoners?
Although the financial crisis created many mortgage prisoners, it’s not the only cause.
The maximum mortgage you can get is based on the ratio of your earnings against the property price – plus any equity you might have from a deposit, or an increase in house value if you’re remortgaging. If any of these factors change, it potentially changes how the bank will treat you.
For instance, in 2013 you may have been accepted for a five-year fixed rate mortgage on a property valued at £300,000, with a salary of £40,000 and a deposit of £100,000. You would be borrowing £200,000 (five times your earnings) with an LTV of 66%.
But a lot could change in the intervening five years. Your equity in the property might increase to £125,000 – and maybe the property goes up in value to £350,000, too. But if you lose your job and get another with a lower salary of £30,000, and mortgage lenders implement a stricter lending cap of 4.5 times your salary, you’d become a mortgage prisoner! To add insult to injury, after those five years are up you’d have to pay your lender’s SVR, which makes it even harder to dig yourself out.
Under the new mortgage lending rules, lenders must also perform a stringent affordability check, find out exactly what your outgoings are to assess if you can afford mortgage repayments, and check whether a change in your income or in interest rates might make the mortgage unaffordable for you. The new stress tests mean lenders have to assess whether you could cope with repayments if the interest rate on your mortgage was 7% or more.
If your outgoings or debt levels have increased, lenders may decide you are too risky to lend to, causing you to become a mortgage prisoner.
Another source of mortgage prisoners – though not one that has significantly affected the UK since the early 1990s because of the general rise in house prices – is negative equity. This was a big issue for some homeowners in the early 1990s who took out a mortgage with a small deposit – and then property prices fell dramatically. They couldn’t sell or remortgage their homes because there wouldn’t be enough money to repay the lender.
Why are mortgage prisoners a growing problem?
Although house price growth in the UK has slowed recently, over the last 10 years most parts of the country have seen prices rise at a much faster clip than real wage growth. As of 2017 the average UK home costs 7.77 times the average income – but mortgage lenders will still only lend around 4.5 times your salary.
At the same time, the number of mortgages available with small deposits is growing, from a handful following the financial crisis, to 190 by 2015 and, according to the latest data from Moneyfacts, 307 by 2018.
Lending to first-time buyers with a small deposit means they can charge a higher rate interest, increasing their profits. This means a greater number of borrowers could be at risk of becoming mortgage prisoners in the future.
What help is available for mortgage prisoners?
If you’re a mortgage prisoner, you can help yourself by overpaying your mortgage and attempting to pay off your mortgage early. This increases the equity you have, makes lenders more likely to lend to you and raises your chances of qualifying for better mortgage rates.
Increasing your annual salary can increase the maximum amount you can borrow, and reducing your debt and other outgoings could help you pass the affordability check, making it more likely lenders will accept you for a competitive mortgage.
If your kids have flown the nest you could downsize to a smaller property or move to an area with cheaper property prices.
The financial regulator is also trying to tackle the issue. In May 2018, the FCA said it wants lenders to do more to help trapped borrowers. It estimates there are 30,000 stuck on expensive rates who can’t switch, but admits there are another 120,000 who have mortgages that have been sold off to investors who don’t offer mortgages.
The FCA suggested that some of these borrowers should be allowed to switch to a cheaper mortgage with their existing lender without undergoing full affordability checks. It also wanted lenders to allow people to switch mortgages if they took out a repayment mortgage before the financial crisis and are up-to-date with payments.
In August, a group of 59 authorised lenders who account for 93% of the UK residential mortgage market agreed to help up to 10,000 mortgage prisoners who have mortgages with authorised lenders, though this won’t help the 120,000 mentioned above or a further 20,000 who have mortgages with inactive lenders.
The group said they’d help borrowers who are up-to-date with repayments switch to new products. They’ll identify and contact eligible customers before the end of 2018, though customers don’t have to switch if they don’t want to.
To qualify, borrowers must have at least two years remaining on their mortgage term and an outstanding loan of at least £10,000. They must also be:
- First charge owner-occupiers
- Existing borrowers of an active lender
- On a reversion rate (i.e. SVR)
- Looking for a like-for-like mortgage
- Up-to-date with payments
- Able to benefit from switching