1. Property & Mortgage Markets

Question 1

Why are first time buyers vital to the overall health of the housing market?

Answer 1

Without these new entrants, homeowners further up the chain are unable to sell and trade up

Question 2

What steps have Government taken to support first time buyers?

Answer 2

• Measures to make buy-to-let investments less attractive
• Exemption from SDLT for first time buyers
• Incentives such as Help to buy ISAs & LISAs & shared ownership schemes, etc
• Planning rules requiring affordable housing to be included in new developments

Question 3

What issues affect the mortgage market?

Answer 3

• Interest rates
• Inflation
• The economy
• Supply and demand
• Government action
• Non-property funding

Question 4

How do interest rates affect the cost of repaying a mortgage?

Answer 4

When rates are high, homeowners struggle to meet repayments, first time buyers cannot afford to enter the market, and house prices are likely to fall.

When rates are low, people find mortgage repayments affordable and will usually be prepared to commit to higher mortgages. The willingness to borrow lifts prices generally, resulting in a property boom.

However other economic factors such as a recession (or a less severe downturn) may lead to lower property prices even when interest rates are low such as in the financial crisis of 2007-09.

Question 5

Explain what are: LIBOR, Bank rate and a Basis point.

Answer 5

LIBOR: London interbank offered rate, the rate at which banks lend to each other. ‘Three-month LIBOR’ means the rate for loans that will mature in three months’ time

Bank rate: The rate at which the Bank of England lends to other financial institutions. You might also see it referred to as a base rate

Basis point: One-hundredth of one percent

Question 6

Are mortgage interest rates more closely linked to bank rate or LIBOR?

Answer 6

Although mortgage interest rates are broadly linked to bank rate, they are more directly affected by the three-month LIBOR.

Historically, the LIBOR or has been between 10 and 20 basis points above the bank rate. E.g. if the bank rate is 2%, the LIBOR is expected to be between 2.1 and 2.2%

This means that in normal conditions, mortgage rates go up and down broadly in line with the bank rate. However, in difficult market conditions the differential can be wider.

Question 7

Historically, by how many basis points does LIBOR follow the bank rate?

Answer 7

Between 10 & 20 basis points.

For example, if the bank rate is 2%, the LIBOR is normally expected to be between 2.1% and 2.2%

Question 8

Many lenders have moved away from traditional variable-rate mortgages in favour of tracker mortgages at follow bank rate or LIBOR. During the boom times it was common for trackers to be set slightly above, or even slightly below bank rate.

What percentage margin do modern trackers tend to have?

Answer 8

Modern trackers tend to have a much wider margin, offering rates as high as 3% above bank rate.

In the past, bank rate has been used as a crude but reasonably effective method of trying to calm or stimulate the housing market.

Question 9

What is Sonia?

Answer 9

The Sterling overnight index average. It is based on wholesale market overnight interest rates. It is seen as close to a risk-free measure of borrowing costs and is based on actual transactions, which makes it difficult to manipulate the figures (unlike LIBOR; see Barclays scandal 2012).

Question 10

Who is working on the transition from LIBOR to Sonia and for what reason?

Answer 10

The Bank of England, together with the FCA and market participants are working on the transition from LIBOR to Sonia as the primary interest rate benchmark for sterling markets.

The transition is expected to be completed by the end of 2021.

Question 11

What affects interest rates?

Answer 11

• Level of government borrowing: when the government needs to raise money for public spending it can raise taxes or borrow; borrowing is less likely to cause political problems. Upward pressure is placed on interest rates when the government increases borrowing significantly.
• Higher levels of individual borrowing: rates tend to move up when there is high demand for borrowing. Too much borrowing at an individual level is a worry for governments as money flows into the economy and prices creep up. If interest rates increase dramatically, many people will be severely overstretched financially.
• Monetary policy: The government uses interest rates as a way of controlling the economy.
• Foreign interest rates: The value of sterling against foreign currencies is affected by interest rates. When UK interest rates are higher than those abroad, the pound is popular and the exchange rate increases. This can have a negative effect on industry because UK goods become expensive abroad and sales may be affected.

Question 12

Which body is responsible for setting the bank rate?

Answer 12

The Bank of England’s Monetary Policy Committee

Question 13

What are the two elements to inflation in the property market?

Answer 13

• General inflation: The decrease in the spending power of money over a period. For example, If inflation runs at 2.5% over a one-year period, £100 at the start of the period will buy goods with approximately £97.50 at the end of the period, i.e. in order to buy the same goods at the end of the period, the buyer will need £102.50
• House-price inflation: relates to the increases in the price of houses over a period. In general, house price inflation runs well ahead of general inflation.

Question 14

What amount of inflation is considered good for the economy?

Answer 14

2 to 2.5% inflation is considered good for the economy.

The government has set the Bank of England a target for inflation of 2% as measured by the Consumer Prices Index (CPI).

Question 15

Through its Monetary Policy Committee, how can the Bank of England reduce and increase general inflation?

Answer 15

Reduce inflation

The Bank of England increases interest rates > People’s disposable income reduces > Prices become generally lower

Increase inflation

The Bank of England lowers interest rates > People’s disposable income and their spending increases > Prices become generally higher

Question 16

How can efforts to control inflation affect house prices?

Answer 16

A prolonged period of interest rate increases to control inflation will lead to stagnation, or even a reduction, in house prices because people will be reluctant to make major financial commitments.

When interest rates are reduced in an attempt to promote inflation, property prices tend to rise as mortgage repayment becomes more affordable.

Question 17

When economic prospects are good why might people have the confidence to enter into a substantial commitment such as a mortgage?

Answer 17

When economic prospects are good, employment is high and stable, and interest rates are relatively low. This feeling of financial stability, mixed with relatively low interest rates give people the confidence to enter into a mortgage.

Question 18

When economic conditions are not so good, why might people hold off from entering into a mortgage?

Answer 18

When economic conditions are not good, people may have to, or choose to, hold off any substantial financial decisions such as a mortgage. In periods of recession, unemployment rises and people worry about their jobs and feel less financially secure.

Question 19

What is negative equity?

Answer 19

Negative equity is a situation in which the market value of a property falls below the outstanding amount of the mortgage loan secured against it.

Question 20

Explain supply and demand in relation to house prices.

Answer 20

E.g. If there are more buyers looking for one bedroom flats in an area than there are flats available, the price will be driven up. Similarly, if there are too many large detached properties, the lack of demand will drive down prices.

Question 21

How can government action affect the property market?

Answer 21

• Help to buy schemes to assist first-time buyers with low deposits.
• First-time buyer SDLT exemption. This is a permanent exemption from SDLT on the first £300,000 of the purchase price for first time buyers.
• 3% SDLT surcharge on buy-to-let properties. As a result of the changes to taxation of buy-to-let property, investors are likely to have to pay more tax. This reflects the government‘s desire to mitigate the impact of BTL investment, since demand from BTL investors is seen to fuel an increase in prices and contribute to the difficulties first time buyers face in purchasing a home.

Question 22

Explain mortgage borrowing for reasons other than property purchase.

Answer 22

Mortgage-secured borrowing for reasons other than property purchase, or even property improvement: a mortgage can provide funding at better rates, spread over a longer term than many other forms of finance. People can use mortgage-secured borrowing to consolidate other debts.

Question 23

Which types of provider offer mortgage finance?

Answer 23

Banks: intense competition in the banking sector has led to an extension in the range of products on offer compared to the 1980s. Banks now actively seek residential and commercial mortgage business which is seen as relatively safe and profitable. They also work hard at trying to sell other products to existing customers (cross-selling). As large institutions banks enjoy considerable economies of scale; they benefit by virtue of their size, being able to raise money more cheaply and take advantage of efficiency is created by the effective use of IT.

Building societies: until 1986, building societies were legally restricted to lending on property in the form of freehold and leasehold estate in the UK. The building societies act 1986 allowed building societies to diversify into new areas including unsecured lending and banking services. Societies must still devote a minimum of 75% of their total lending activities to residential mortgages, although they can convert to plc status if they wish to enjoy the same freedom as banks.

Insurance companies: Insurance companies can be general insurance, life assurance or composite offering both types of business. Traditionally, life companies have occupied a small corner of the mortgage market. As the competition for mortgage business has intensified, insurers have lost some ground in the provision of loans but have undoubtedly gained by selling services alongside mortgages offered by other providers.

Specialised mortgage companies & challenger banks: known as centralised lenders, specialised mortgage houses are funded from the wholesale market and lend on a centralised basis; they have a few, if any, branches and operate primarily through intermediaries. The rise of challenger banks and specialised lenders have increased competition.

Question 24

What percentage of their total lending activities must building societies devote to residential mortgages?

Answer 24

75%

Although they can convert to plc status if they wish to enjoy the same freedom as banks. In the 80s and 90s societies such as Abbey National, Northern Rock, Alliance and Leicester and Cheltenham and Gloucester all did this.

Question 25

What is capital adequacy and what are the key aims of capital adequacy requirements?

Answer 25

Capital adequacy requirements are designed to ensure that a business holds sufficient reserves of capital to be sustainable. Regulations broadly state that should a business run into difficulties, the business must have sufficient capital to make it very unlikely that deposits will be placed a risk.

Question 26

What are mortgage packagers?

Answer 26

Mortgage packagers are, in effect, middlemen who operate between the ultimate lender and the intermediary or customer. The role is to undertake much of the administrative work, tailoring mortgage arrangements to specific situations.

Question 27

What is prime and sub-prime lending?

Answer 27

Prime lending is lending to borrowers who meet the lender’s standard criteria and present a normal risk.

Sub-prime lending is lending to borrowers who represent a higher risk than normal.

Question 28

What are some of the features of a sub-prime borrower?

Answer 28

Those with a poor credit history - for example, those with County Court judgements against them or a number of previous payment defaults

Those who have difficulty proving certain elements of their income

Those who do not fit the lender’s normal borrower profile in terms of occupation, age, residency, and type of income, etc

Those who are self-employed and either have a short track record in the business or cannot supply the required number of previous years accounts

Question 29

What is often referred to as ‘setting the rate for risk’?

Answer 29

This is when a lender may choose to charge a higher rate of interest to compensate for any additional risk presented, usually by a sub-prime borrower

Question 30

What is a second charge loan?

Answer 30

A second charge loan is a loan secured on a property registered after a mortgage (first charge). It will rank second in line for repayment on sale or repossession. This means that it will be repaid from any money left over after the first charge holder has been repaid. If there is insufficient money to repair the second charge holder, the lender will lose out.

Question 31

What is bridging finance?

Answer 31

Bridging finance may be required when a borrower wishes to move house but has not managed to sell the existing house, or the funds from the sale will not be available at the time of completion of the new purchase is due. It is short-term lending that is repaid when the original property is sold and the owner is able to secure a mortgage on the new property.

Question 32

Specialised (centralised) mortgage lenders raise funds for mortgage lending where?

Answer 32

The wholesale market

Question 33

A recession is usually defined as a decline in gross domestic product over how long a period?

Answer 33

Two successive quarters (or 6 months)

Question 34

Sale and rent back arrangements involve a company buying a property from its owner…..

Answer 34

…. usually below market value, then renting it back to them.

Question 35

The process of packaging a number of mortgages into ‘bundles’ and selling them to other institutions is known as?

Answer 35

Securitisation