Maligned banking practice could help rebalance UK mortgage market, study suggests
Securitisation, where investors buy pools of debt from banks as secured assets, has enabled mortgage lenders in the UK to offer an increased number of lower risk, long term fixed rate mortgages, it is claimed.
Securitisation was originally intended to free up funding for banks, allowing them to sell packages of mortgage loans and lend out the proceeds to more customers. Those loans could then be sold on, and the cycle could start again.
The process was also intended to reduce risks for banks by spreading the ownership of mortgages and other loans among other investors but it came under scrutiny during the global economic downturn and used less frequently as a result.
However, a new study of long term market trends by Dr Alla Koblyakova and Professor Michael White, of Nottingham Trent University’s Real Estate Economics and Investment Research Group, has found that 78% of mortgages sold as securities over a nine year period were held in longer term fixed rate contracts.
‘This is an important finding as it shows that securitisation not only increases liquidity in the market but has the potential to shift consumer mortgage choices toward long-term fixed rate mortgage debt,’ said Koblyakova.
‘In a market like the United Kingdom’s, where around 80% of residential mortgage debt is held in higher risk variable rate or short term fixed rate contracts, this is a very welcome finding,’ he claimed.
‘A high level of variable debt is seen as a source of economic instability. Policymakers may wish, therefore, to consider the potentially beneficial role that securitisation can play in helping balance the UK mortgage market,’ he added.
According to the study variable rate and short term fixed rate mortgages are more risky for borrowers as they leave them more vulnerable to financial shocks, such as interest rate increases. By contrast, longer term fixed rate deals protect borrowers from such increases, but leave lenders more exposed to these risks.
Koblyakova believes lenders may be more inclined to offer longer term fixed rate mortgages to borrowers when these mortgages are sold on as securities because this reduces the lenders’ exposure to risk.
The study also found that variable rate mortgages were more profitable for lenders than long term fixed rate mortgages by as much as 1.6%. For every 1% of profit a mortgage lender makes from a variable rate mortgage, the market share of variable rate mortgages increases by 18%. This is despite the data also suggesting that consumers prefer to take out longer term fixed rate products.
‘According to this data, larger profit margins for variable rate mortgage products positively influences demand. These findings are very important, and should stand as a call for action for policymakers, as they show that UK households may be faced with greater payment shocks because of the strategies of lenders,’ Koblyakova concluded.
White pointed out that the regulation of financial products such as mortgage backed securities is regarded as a key issue in the global financial crisis. Securitised products are argued to have had credit ratings that suggested they were lower risk than was actually the case.
‘But it's clear from this research that securitisation, providing it is tightly regulated, has the potential to provide borrowers with increased access to lower risk mortgages. What’s also clear is that the UK mortgage market may be dominated by variable rate and short term fixed rate mortgages because lenders make more money from these products, not because they are the consumer’s first choice of mortgage,’ he said.