Era of cheap credit could be over, says UK expert

The era of cheap credit may be over forever, the chief executive of Britain's Financial Services Authority has warned.

Hector Sants said he believed the financial markets will never return to the practices seen before the global credit crunch hit last summer.

The impact on the sub-prime mortgage sector of the wholesale money markets drying up has been well documented, with firms hiking their rates and reducing the proportion of a property's value they are prepared to lend on.

As funding constraints continue however, other borrowers are now being caught up in the problems.

First-time buyers, particularly those struggling to raise a deposit, are the latest to be hit by the crisis, while there are also reports of growing numbers of people who took out their first mortgage two years ago, struggling to remortgage.

Ray Boulger, senior technical manager at John Charcol, said: "All of these borrowers are going to be in the firing line.

"The sub-prime market was affected very quickly and very badly, but that does seem to have run its course, and the main mortgage market is being hit with lenders continuing to put up their tracker rates."

Last week saw the dramatic withdrawal of all lenders from the 125% mortgage market in a matter of days.

These loans, which enable people to borrow up to 125% of the value of their home, were particularly popular with first-time buyers as they removed the need to save for a deposit, while also providing extra cash to cover stamp duty and solicitors' fees.

The rout began with four of the six lenders who offered the deals withdrawing them on the same day, and by the end of the week all lenders had pulled the products.

At the same time Scottish Widows Bank announced it was exiting from the 100%-plus mortgage market, leaving Dunfermline Building Society the only lender that will advance more than a property is worth, although it only offers the product to professionals and graduates in Scotland.

Lloyds TSB also said it would no longer be offering 100% loans, while people taking out a mortgage with its subsidiary Cheltenham & Gloucester will now need a deposit of at least 10% after it pulled its 95% products too.

There has been a marked reduction in companies that are active in the 100% mortgage market. The number of lenders offering these loans has more than halved during the past three months to just 16, with more to follow.

It is not just first-time buyers who are running into problems as lenders look to reduce the level of risk they have on their books.

Many lenders are also reducing the so-called loan to value (LTV) ratio borrowers need to qualify for their best rates, while also raising the premium they charge people wanting to borrow 95% of their homes' value.

Julia Harris, a mortgage analyst at Moneyfacts.co.uk, said: "Previously we saw products at 95% competing for best buy positions, now it seems that due to the increased risk, in a more uncertain market, products with a maximum LTV of 95% are being priced accordingly and therefore unable to compete for the top spot."

Nationwide Building Society recently reduced the LTV people need to qualify for its best deals from 90% to 75%, and the group's move is part of a wider trend as lenders increasingly focus on their margins.

Louise Cuming, head of mortgages at Moneysupermarket.com, said: "I think it will be a trend that other lenders will follow.

"All the lenders are saying they are not going for volume and market share, but profit and margin, and also low risk customers, who are those with equity in their property."

The move is causing problems for people who bought a property two years ago and who are now coming to the end of fixed rate deals and need to remortgage.

The situation is not being helped by stagnant and even falling house prices, meaning people are unlikely to have seen big reductions in their LTVs due to price appreciation.

Ms Cuming said: "We have already started to see the impact on people who had 95% mortgages but had higher lending charges added to them, making them 97%-plus and they are finding it hard to remortgage.

"There will be people (who took out a mortgage) in the last two years who are going to struggle. Surveyors are being very cautious when they put remortgage values on properties.

"Over the last couple of months we are finding at Moneysupermarket.com one of the biggest reasons why applications aren't being successful is that people are overly optimistic on valuation."

Even those wanting to borrow a lower proportion of their property's value are facing higher rates as lenders pass on to customers the increased wholesale funding costs they themselves face.

Figures from Moneyfacts.co.uk show that the best buy two-year variable rate mortgage currently available in Britain is now 5.19%, compared with a leading rate of 4.73% in March last year before the problems began, despite the Bank of England base rate being at 5.25% in both months.

Mr Boulger said tracker rate mortgages were now typically around 0.5% higher in relation to the base rate than they had been six months ago, effectively negating the two recent interest rate cuts for new borrowers.

"Any lender that comes out with a competitive deal gets flooded with business that they can't cope with, so they have to pull the rate, even when they are getting a good margin," he added.

"Those lenders that do have money to lend don't have the capacity to cope with all of the business they are getting."

He added that in the sub-prime sector, some lenders were offering very expensive rates designed to get them very little business, while enabling them to remain in the market.

All of the problems in the mortgage market are beginning to take their toll on lending volumes, with the number of home loans approved falling in recent months.

Sue Anderson, of the Council of Mortgage Lenders, said: "The market as a whole still looks set to suffer a funding shortfall this year between the amount that we think consumer demand would support, and the amount that retail funding alone can supply.

"Unless we get more non-retail funding back into the market, it will be a constrained market."

At the beginning of the year, the CML estimated that demand for net lending during 2008 would be £90bn (€117.6bn), but retail funding would only be able to meet £60bn (€78.4bn) of this, meaning that as much as a third of demand could go unmet.

Although the CML thinks the situation may have eased slightly since then, it still expects there to be a "significant imbalance", with British eople looking to buy a home the most likely to suffer.

Ms Anderson said the shortage of funding would lead to a contraction of the availability of credit in certain parts of the market, particularly for people with adverse credit.

She added that lenders were also likely to restrict who they lent to in other parts of the market by continuing to tighten their lending criteria and reducing LTVs.

The fall in lending availability is inevitably having a knock on effect on the British housing market, further constraining demand at a time when it is already subdued.

Mr Boulger said: "It's clearly going to have a negative impact on the housing market because the availability of mortgage funding clearly has a major impact on the market."