The learning objectives for this blog are to:

• Understand the key elements that make up mortgage products.
• Understand why funding is so important in the supply of products.
• Understand how the balance of these elements can impact the choices brokers make for clients.

As everyone must recognise now, the days of historically low interest rates are well and truly behind us. The heady mix of global and national inflationary pressures means we are set on a course of rising interest rates until the end of the year according to most market observers.

Indeed, for the last eighteen months, rates have risen quickly presenting new challenges to brokers, borrowers, and lenders challenging assumptions and processes that have remained relatively unchallenged for over a decade. Until the latest cycle of interest rate rises it was perfectly possible for many working in financial services to have never needed to understand how a Standard Variable Rate works, or how Swap rates impact future interest rate expectations.

Mortgage product propositions are the sum of a few variables – each of which matters in its own right but its importance varies depending on market, regulatory and funding environments. We thought a quick tour through these might be helpful.

It's all about price, isn’t it?

Evidently, pricing is key, and it is the function of treasury and product departments to arrive at pricing that meets the needs of borrowers in the specific market the lender operates in. The product is designed for borrowers but must deliver a return to other stakeholders – be they the members of a Building Society or shareholders of a privately or listed organisation. In a benevolent lending environment, where product availability is relatively easy and lending appetite robust, pricing becomes key and much of the technology available to source products focusses on this.

But pricing is not the only game in town, especially when the credit cycle turns, and lending becomes sparser. It is also one reason lenders provide loans to many different micro markets to avoid being in a continual price war and breaching responsible lending obligations.

Criteria – risk appetite changes

Product criteria encompasses those elements a lender will use to reflect their risk appetite. It breaks into two parts. The person to whom the loan is made and the security upon which the loan is made. Self-employment, for example, is a typical area where lenders requirements will differ according to their understanding and ability to look at accounts and multiple sources of income.

The criteria will also apply to the property security – where in many cases certain types of build, alterations, construction styles, material etc will mean a property is either included or exempted from lending. But it is not restricted to the physical elements – EPCs for example may impact a decision to lend.

Affordability – the relatively new game in town

Two years ago, affordability would unlikely have been mentioned in a piece about products and yet today it is the principal concern for lenders. To compound the difficulty, it is the least visible part of the product mix. Most lenders of residential mortgages use either one or both income and expenditure data from the Office of National Statistics, which in times of stability works well enough. The data though is not timely, often on six month or annual feeds, and so the onset of the cost-of-living crisis, prompted some urgent action.  The result was that some effectively exited themselves from the market and needed to rethink their decisions in the light of re-pricing and looking at criteria too. Many lenders added a notional 10% across the board but now this is more nuanced in many cases. Lenders may apply uplifts in discrete areas and review their decisions quarterly or more often as circumstances demand. It’s ironic given the removal of the FPC affordability test in August 2022.

Lenders are investing a lot of time and effort into this area to improve their understanding of borrower affordability and many systems to help with income are becoming available such as Automated Income Verification, payroll and HMRC data.

Service – efficiency matters all the time

This is a feature of mortgage lending that has improved immeasurably over the years but ultimately will always play second fiddle to other elements of the mix if the pricing and availability is right. However, speed and efficiency in the process are very important – whether a borrower needs help to meet an exchange deadline or avoid a costly move onto a lender’s SVR. The motivations and focus of efficiency may shift but ultimately, they are never absent and play an important part in delivering a less fraught experience for brokers, borrowers and lenders alike.

We know that getting certainty of decision early is important to everyone and so it is in everyone’s interests to do this. It’s why so much time and effort is invested in systems and third party data sources to offer certainty earlier in the process.

Funding matters

In the current lending environment, funding refers largely to fixed rates. These are funded by reference to swap rates which are the market’s expectation of the cost of future money i.e., what the markets thinks interests will be in the future.  If these rise, then mortgage lenders will increase their rates so that they don’t lose out. Generally, speaking, if swap rates go down, mortgage rates go down. If they go up, so too do mortgage rates.

Prior to the change in economic climate, the swap rates were relatively stable reflecting the broad acceptance of a low interest rate environment for the foreseeable future. That has changed. That has changed and the ensuing volatility require agility from lenders when pricing their mortgages.

Swap rates are a way of mitigating interest rate risk by securing funding money at a fixed price with a view to repricing a product when that mortgage tranche expires. However, when it does, lenders need to be quick to reprice to protect margins. No one wants an environment where pulling products at short notice is the norm but the funding environment of volatile swap rates, mixed inflation data, digital access and algorithms means things move very quickly.

The funding options available to lenders matter too. Depending on the type lender, there are two basic sources of funding. The first is retail deposits, the second is wholesale markets – whether that be through direct lending (e.g., via another bank) or through a capital markets instrument like securitisation.

The last year has shown lenders that diversification in your sources of funding does offers advantages.  Relying solely on deposits or wholesale markets means you will not be able to take advantage of the relative costs of funding in each market at any point in time.  For example, UK deposit funded lenders have seen foreign banks attract UK deposits and wholesale funders have seen spreads widen during periods of heavy issuance.

It's one reason why lenders like us, who rely solely on wholesale funding are in the process of gaining regulatory approval for a banking license so that we can also fund from deposits. The more strings to your bow, the more music you can play.