The Business of Mortgages
A quick guide to the past, present and future of mortgages.
Introduction
The world of mortgages can seem impenetrable to anyone who hasn't bought a house before (and to many people who have). Like all lending, the principles are simple but, due to the vast sums involved and the industries that have been built around them, there are numerous layers of complexity. Let's make a cup of tea, take a step back and look at the mortgage business as a whole.
Note: This is not intended to be a primer on mortgages but a look at the wider market.
The Past
Pre-20th century
‘Mortgage’ or ‘mort’ ‘gage’ stems from French and means ‘dead pledge’. Dead in the sense that the pledge will be dead once it is paid, rather than only death will free you of the pledge. The alternative was a ‘live pledge’ or ‘vif guage’ where the borrower used income from the land to pay the lender. The old vif-guages tended to be more popular as mort-gages encouraged ‘usury’ (charging interest that unfairly enriches the lender) which was both a sin and against the law. The first recorded mention of a ‘mortgage’ was in English common law documents in 1190.1
20th Century
Up until the start of the 20th century, 90% of people still rented (if living in a slum can be called renting).2 After several years of horrific trench warfare the government thought it might be nice if the returning soldiers had somewhere decent to live and initiated the ‘Homes fit for Heroes’ campaign. In 1925 mortgages became recognised under the law.3
It was in the second half of the 20th century that mortgages really took off as more people bought homes. In the 80s and 90s the growth of the market alongside deregulation allowed the development of numerous types of mortgages to suit different circumstances.
2008 and beyond
The economic turndown in 2008 was largely caused by subprime (or ‘shit’ as Margot Robbie explains here) mortgages. In essence mortgages were being doled out left right and centre with minimal regulation and high levels of defaults in the US particularly. As a result of the economic chaos caused by what amounted to dodgy mortgages, regulation has tightened across the globe. This makes it harder than it ever has been to secure a mortgage.
The UK market today
There are around 340 registered mortgage providers in the UK.4 The familiar high street lenders dominate the mortgage market with Lloyd’s having the largest share at 19.5% in 2020.5 There are a number of challenger banks such as Metro and Atom but so far neither these nor fintechs have had the impact on the market many people expected. For all the snazzy coloured cards used to buy avocado on toast, they still account for a relatively small portion of the market.
What impacts the mortgage market?
Lending in the form of mortgages makes up a huge percentage of the economy. In 2021 there is £1.6 trillion of mortgage debt outstanding6 which, however you look at it, is a lot of money. The health of this debt - ensuring that it is being repaid and is underpinned by a viable housing market - is always a government priority and they usually have two key cards up their sleeve to manage it.
Interest rates
Central banks (such as the Bank of England (BoE)) are tasked with maintaining the stability of the country's financial system. They have a number of tools at their disposal but the main one is setting the interest rate (base rate) at which commercial banks (Barclays, HSBC etc) can borrow from the BoE.7 This then affects the products they provide. If it is costing them more money to borrow then this cost will be passed on to whoever is borrowing, hence how it impacts the cost of a mortgage.
The housing supply
Like any market, housing is heavily impacted by supply and demand which in turn affects the behaviour of lenders. The UK has an undersupply of homes, partly due to the limited amount of space on our island which means prices will most likely continue to be pushed higher until we all get bored of the cold and move to Benidorm. The UK housing market looks to remain strong and so from the perspective of a lender the underlying asset looks to be secure, meaning mortgages are an appealing product to sell.
How do mortgage providers make money?
On the surface it’s quite simple: Bank A (let’s call them Boyd’s) collects a whole load of savings deposits from Mrs Goggins, Alan the undertaker and Charlotte the social media manager. Soon Boyd’s has enough money to lend to Eric and Ernie to buy a flat in Swaffham. Eric and Ernie pay Boyd’s some of the money lent back plus interest each month. That interest is how the bank makes its money and what enables them to have enough for Mrs Goggins to withdraw £1000 when she decides to buy a surfboard.
There are four primary ways a lender makes money from this situation:
Fees
Lenders usually charge an origination fee which is the fee for signing you up and setting up the mortgage.
Interest (Yield Spread Premium)
This is the difference between the interest the lender is charging Eric and Ernie for their mortgage and what it is paying Mrs Goggins, Alan and Charlotte to borrow the money, which the lender pockets.
Securitisation
Sometimes, Boyd’s will sell the mortgage relatively quickly onto a secondary market. This is known as securitisation when a load of debt is bundled together and sold as a ‘security’. This practice got a lot of bad press during the financial crisis (see The Big Short (again)) but securitisation is partly what pays Mrs Goggins’ pension and enables banks to maintain more liquidity which is a good thing. Currently this is a much bigger feature of the US market than in the UK, due to the majority of UK mortgages only being fixed for 2-5 years.8
Other products
There are a number of different products including insurance which lenders attempt to sell and sometimes mis-sell. They are the mortgage equivalent of “would you like anything to eat with that?” when you buy your coffee.
The Future
The main factors impacting mortgages in the future will be the macroeconomic ones around house prices, inflation and the performance of the wider economy which would be foolhardy to try and predict. But what will mortgage lending look like for the individual in the future?
The whole process of borrowing will no doubt become more slick and seamless as it already has done. But at a slightly more structural level, it seems plausible to suggest that, through technology, it should be much easier to develop tailored products for the individual, taking into account their circumstance. There are metrics beyond simply our credit score and income that could determine how much we can borrow and how any additional risks could be mitigated. This would be an enormous boon for first time buyers and people with irregular sources of income.
The limiting factors here will not be technology9 but regulation and how much we are prepared to share our data with lenders. In the same way you can get a better insurance deal if you have a ‘black box’ in the car, giving lenders more access to our personal information may enable them to make more informed decisions which could benefit you. There is of course a trade off between the privacy of our data and the ability of businesses to tailor their products for us.
There is also a trade off with regulation. No one wants another 2008 crisis but enabling lenders to be more flexible within established parameters, could dramatically increase access to home ownership.
Another potential area of growth is consumer access to secondary mortgage markets. Traditionally mortgage backed securities have only been accessible to institutional investors, but in the same way investing in stocks and shares has become democratised, it is plausible this will happen for other products. This would offer investors a midpoint between the next to nothing interest rates achieved through cash savings and the riskier world of equity investing.
There is a wider question on the future of securitisation as we move to a subscription based society. Pipe has already launched a product that enables people to invest in software subscriptions, providing capital to the software company and income to the investor.
Conclusion
Mortgages will continue to be a central pillar of the economy but we have reached a point where borrowing has never been harder and interest rates are at an all time low. This has the dual effect of leaving a large proportion of society unable to access mortgages and making it hard for lenders to differentiate their offering. The long term solution feels like smarter regulation and more tailored lending.
Industry source
The surprising future of mortgage technology - HousingWire