The surge in popularity of second charge mortgages is a testament to how specialist lending can provide stability in times of uncertainty. But for how long?
As many predicted, 2023 has had a difficult start. Affordability remains a key barrier for both first-time buyers and homemovers; rates continue to fluctuate, creating uncertainty for homeowners on whether to choose a fixed or tracker deal; and the potential dip in property prices is being quoted at up to 10%.
Clients need to understand their future affordability when reviewing their budget for a second charge
As a result, many are putting their moving plans on hold until the market picks up. Some homeowners are even deciding if it’s worth making home improvements or consolidating debts due to the rising cost of living. This has led to an increase in second charge mortgages as many borrowers aim to avoid any early repayment charges (ERCs) that may come with remortgaging.
The Bank of England observes: “Currently, 74% of homeowner mortgages are on a fixed-rate mortgage, with 96% of new borrowers choosing this option since 2019. Furthermore, the proportion of fixed-rate mortgage borrowers opting for five-year fixed rates has increased significantly in recent years, from fewer than three in 10 borrowers in 2017 to around 45% of borrowers in 2021.
“The proportion of those on two-year fixed rates has seen a decrease of a similar magnitude over the same period, suggesting an increasing number of borrowers have been locking in for longer to take advantage of the near-record low rates.”
Brokers must show their reasons for recommending a second charge and discounting a further advance or remortgage
When we consider fixed rates were as low as 0.79% in October 2021, it makes sense that borrowers grabbed a low fixed rate while they could, especially with continuous impending base rate rises. This continued until August 2022 before events took a turn for the worse.
Strong growth
With most homeowners tied in to longer fixes, raising extra funds can be difficult, especially when the existing lender deems this unaffordable and the alternative of paying an ERC and moving to a new lender at a higher rate may be costly. As a result, the second charge sector recorded strong growth in 2022. The value of new business rose by 40% year on year, while the 33,772 new agreements were the highest annual total since 2008.
Although first charge rates have reduced slightly, second charge rates continue to be in excess of 7.5%
Homeowners’ knowledge of second charges is fantastic news for the industry, given the sector’s past murky reputation. It enables us to support our clients and continually build relationships with them.
I am a huge advocate of the specialist space and appreciate the dedication of lenders as they continually develop and adapt criteria to support clients with complex needs. Nonetheless, for all the positive aspects there are potential factors that need to be considered to protect consumers, brokers and lenders.
Consumer duty
The FCA states: “The Consumer Duty is a significant shift in our expectations of firms. It introduces a more outcomes-focused approach to consumer protection and sets higher expectations for the standard of care that firms give customers.”
Homeowners’ knowledge of second charges is fantastic news for the industry
With emphasis on the client and ensuring the right outcomes, brokers must show their reasons for recommending a second charge and discounting a further advance or remortgage.
Future affordability
First charge fixed rates are not expected to return to 1% or 2%. For many homeowners who bought a property in the past five years, fixed rates at the current level may not have been taken into consideration.
Clients need to understand their future affordability when reviewing their budget for a second charge; they should assume their first charge mortgage will be at a higher rate (in line with rates now) rather than base their affordability on their existing low mortgage rate.
For how long can specialist lending provide stability?
An additional consideration is that a first charge lender may be unable to raise funds to clear the second charge in the future.
Impact of a potential fall in prices
This affects a smaller proportion of second charge homeowners but, because lenders that deal with higher LTVs typically cap the maximum borrowing, in the event of property prices dipping by 10% some borrowers with high LTVs could fall into negative equity.
Rates and stress tests
Although first charge rates have reduced slightly, second charge rates continue to be in excess of 7.5%. With the higher costs involved and the impact this has on buy-to-let interest cover ratios, if rates don’t decrease in the future we could see a decline in the number of borrowers opting for a second charge mortgage.
Nicholas Mendes is mortgage technical manager at John Charcol
This article featured in the April 2023 edition of MS.
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