The unintended consequence of long term repayment loans

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Anyone involved in the residential mortgage industry will not have missed the steady, and now significant, uptick in the number of lenders offering longer terms alongside their mortgage range.  It seems a day doesn’t go by without ‘X’ lender announcing ‘we have extended the maximum term for all residential mortgage to 40 years’, or words like that.  I know one lender who routinely considers 45 year terms.  The headline is usually accompanied by statements such as, ‘it is expected that this change will help customers spread their payments over a longer term allowing a wider range of customers to secure financing with terms that suit their individual needs’.  Unpicking this code, it simply means we have amended our affordability assessment to lend more money.

It’s now reported that a quarter of homeowners under 30 now have repayment terms on their mortgage of 35 years or more.  One doesn’t need to be a brilliant mathematician to work out that means that is a hell of a lot of people who will be clearing their mortgages around, or after, the current state pension age.  Even planned increases in this date won’t provide relief for many who will be forced to continue working, just to pay their mortgage.

It’s now reported that a quarter of homeowners under 30 now have repayment terms on their mortgage of 35 years or more. 

I may be ‘teaching grandma to suck eggs’, but it’s worth noting the potentially adverse consequences of longer term repayment mortgages?  To focus on just five:

  1. Paying more interest over the whole term: With longer mortgages, customers will pay far more interest overall.  For example, a mortgage of £100,000, at a typically current SVR of 8% interest rate would result in significantly higher total interest paid over 40 years (£233,738) compared to a 25-year term (£131,545).
  2. Higher total repayment: While longer mortgage terms result in lower monthly payments, they lead to a higher total repayment over the life of the mortgage due to the extended term and the accrual of interest.  Using the above example, total payments over 40 years (£333,738) compared to a 25-year term (£231,545).
  3. Reduced flexibility: Longer mortgages have lower monthly payments because the capital is repaid more slowly.  This reduces future flexibility and takes away potential ‘forbearance’ tactics such as term extensions.
  4. Risk of negative equity: As the capital is repaid more slowly, longer mortgage terms may increase the risk of being in a state of negative equity for a longer period.
  5. Early retirement options are removed: As customers are locked in repayments for all their working life, early retirement options are limited.

Clearly, there are potential downside risks for consumers arranging long term repayment mortgages.  My question then is who is thinking about the long-term needs of the customer?  Surely, in today’s world ‘Consumer Duty’ should be the yardstick to measure the effectiveness of any consumer interaction in the financial services world?  If so, back to basics, what is the foundation of Consumer Duty?  The original FCA Dear CEO letter titled “Implementing the Consumer Duty in mortgage intermediaries” (issued 3 March 2023), it was a good starting point back then, and is equally relevant now.  The FCA messaging is clear,

  • Intermediaries need to design services that meet the needs, characteristics and objectives of specified target markets,
  • Offer products that provide fair value with a reasonable relationship between the price consumers pay and the benefits they receive,
  • Communicate with consumers in a way that enables them to make effective, timely and informed decisions,
  • Support consumers needs throughout the life of the product or service they provide.

I am not, of course, saying that long term repayment mortgages are always wrong, but terms should not be recommended by default simply because the lender allows them or to aid short term ‘affordability’ where it is not a specific customer need.  If firms really embrace Consumer Duty, and if it is to be the success that everyone hopes it will be, firms will need to ensure consumers really understand the potentially unintended consequences of their decisions.  So the question for firms to address is, what processes are adopted to address different risks in different length of mortgage term advice, how are risks presented to consumers and how do firms assess consumer understanding of those risks?

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Partner - Baxters Business Consultants - a business consultancy undertaking marketing, training, freelance journalism and expert witness services to the residential mortgage lending, building society and financial service industry (April 1993 to date) - www.baxtersbc.co.uk.

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