What is a mortgage prisoner and how can you escape?

Homeowners, dubbed “mortgage prisoners”, are those trapped on their current mortgage (and mortgage provider) because they are unable to switch to a new mortgage.

How do you become a mortgage prisoner?

If you cannot leave your current mortgage because your financial circumstances have changed, then you become a mortgage prisoner.

Your new financial situation could prevent you from passing a lender's affordability checks. You're trapped on your existing mortage even if a remortgage would mean you were on a cheaper deal.

This is a real problem if you have a large mortgage, or you’re on your lender's SVR (standard variable rate). You're automatically put onto an SVR mortgage when the promotional deal on your current mortgage ends.

The average SVR interest rate is around 4.9%, compared to the average 2 year fixed rate mortgage which is about 2.4%. So your repayments while on an SVR will be much higher than if you were on a fixed rate deal.

The impact of the global financial crisis of 2008 on mortgages

The first big wave of mortgage prisoners happened as a result of the 2008 global financial crisis. Before that, banks were prepared to offer much bigger mortgages, some as much as 125% of the property value.

Prior to the 1996 property price boom, the average price of a UK home was only £51,000. This was about 3.5 times the average UK salary, which was around £14,500.

The maximum amount you could borrow was about 4 times your salary, and you'd need a deposit of around 10%.

In the early 2000s, 100% LTV mortgages (i.e. no deposit mortgages) were common, the self-employed could self-certify their income, and banks were prepared to lend up to 8 times your annual salary.

As a result, many people borrowed heavily. With house prices rising much faster than salary growth, the gap 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.

After the financial crisis, the UK’s financial regulator, the FSA (now the FCA) ordered a review to tighten mortgage lending rules.

As a result of the new lending criteria, borrowers would have to pass strict affordability checks before they were approved for a mortgage. Lenders would scrutinise their credit files to be sure they could afford to meet the mortgage repayments.

When borrowers who'd previously borrowed heavily tried to negotiate a new mortgage deal, lenders turned them down. It wasn’t called the credit crunch for nothing!

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.

There were 2 other factors during the financial crisis that led to the creation of mortgage prisoners:

  • Interest only mortgages
  • Mortgage lenders that went bust

Many borrowers with interest-only mortgages had little or no equity in their property when the mortgage lending rules were tightened.

Lenders like Northern Rock and Bradford & Bingley collapsed during the financial crisis and sold off their mortgage portfolios to investors. These investors are often unregulated and do not have to follow FCA guidelines leaving borrowers unprotected.

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
  • Any equity you might have from a deposit
  • An increase in property value if you’re remortgaging

If any of these factors change, it potentially changes how the bank treats you.

For example, in 2013 you may have been accepted for a 5 year fixed rate mortgage on a property valued at £300,000, with a salary of £40,000 and a deposit of £100,000. You'd need to borrow £200,000 (5 times your earnings) with a 65% LTV (loan-to-value).

But a lot could change in those 5 years. Your equity in the property might increase to £125,000, and the property value could go up to £350,000. 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 would struggle to get a new mortgage...and you'd become a mortgage prisoner!

To add insult to injury, after those 5 years are up, you’d have to pay your lender’s SVR, making it even harder to dig yourself out.

Under the new mortgage lending rules, lenders now have to scrutinise your credit file and your spending habits before they approve your mortgage application.

They also have to check you could afford the repayments if you had a change or income or interest rates increased by 4% above the SVR. This is known as stress testing. If you do not pass these tests, you may not be able to get a new mortgage and you'll be a mortgage prisoner.

Another reason for mortgage prisoners is negative equity. Negative equity is where your mortgage is bigger than your property value. It was a big issue in the 1990s when house prices dropped dramatically.

These homeowners could not sell or remortgage their homes because they would not have enough money to repay the lender.

Why are mortgage prisoners a growing problem?

Although house price growth has slowed recently, over the last 10 years most parts of the country have seen prices rise much faster than real wage growth.

In 2017, the average UK home cost 7.77 times the average income, but most mortgage lenders only loan a maximum 4.5 times your salary. So, you'd need a huge deposit to buy a property.

But the number of mortgages available with small deposits (some at just 5%) is actually growing. Following the financial crisis, only a handful allowed this, increasing to 190 by 2015 and, according Moneyfacts, 307 by 2018.

Lending to first time buyers with a small deposit means they can charge a higher rate of interest.

This means a greater number of borrowers could be at risk of becoming mortgage prisoners in the future.

What help is there 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.

Check with your lender how much you can overpay without being charged a penalty fee.

Increasing your equity makes lenders more likely to lend to you and raises your chances of qualifying for better mortgage rates.

Getting a pay rise can increase the maximum amount you can borrow. Reducing other debt and outgoings could also help you pass a lender's affordability check, making your acceptance onto a cheaper mortgage more likely.

Consider downsizing to a smaller property or moving to an area with cheaper property prices if possible.

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 cannot switch, but admits there are another 120,000 who have mortgages that have been sold off to investors who do not 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. This, however, will not help the 120,000 mentioned above or a further 20,000 who have mortgages with inactive lenders.

The group said they’ll identify and contact eligible customers before the end of 2018. Customers do not have to switch if they don’t want to.

To qualify, borrowers must have at least 2 years left on their mortgage term and an outstanding loan of at least £10,000. They must also be:

  • Living in the house they're trying to remortgage
  • 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

Between March and June 2019, the FCA investigated and consulted with the industry on further measures to help mortgage prisoners.

The FCA released its new guidance on 31 October 2019. Under these rules, mortgage prisoners may be released from their shackles if they are:

  • Up to date with their payments
  • Remaining in the property
  • Not planning to borrow more money

Unregulated companies and inactive lenders who bought the mortgage portfolios from lenders that went bust must tell their customers they are allowed to switch deals.

Although this is a step in the right direction, many industry experts think more needs to be done to release mortgage prisoners.

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Last updated: 1 November, 2019

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