Navigating Interest Rates and Consumer Duty: Challenges Facing Mortgage Lenders in Turbulent Times

The recent decision by the Bank of England to raise interest rates has sparked significant concerns and implications for homeowners, renters, and the overall lending landscape. With inflation remaining stubbornly high at 8.7% in May (according to the Office for National Statistics, more than four times the government's target), the 0.50 percentage point increase was widely anticipated. This move brings the Bank Rate to its highest level since 2008 and with the financial market predicting that interest rates will continue to rise, potentially reaching 6% by early next year, it will continue to add further strain to borrowing costs. 

This rate rise marks the 13th since December 2021 when the Bank rate stood at a mere 0.1% and aims to reign in inflation, bringing it back down to the 2% target. However, the direct impact on millions of homeowners cannot be ignored, as their UK mortgage rates are linked to the central bank's base rate. Renters are also likely to experience a ripple effect, facing increased payments as buy-to-let landlords pass on higher mortgage repayments. 

Research conducted by the National Institute of Economic and Social Research, suggests that this latest interest rate increase by the Bank of England could push 1.2 million UK households (accounting for 4% of households nationwide) to exhaust their savings by year-end due to higher mortgage repayments, with some households facing paying an additional £5,000 a year on their mortgages. Consequently, many households with mortgages will teeter on the brink of insolvency. 

New adjustments to mortgages 

The trajectory of mortgage rates has been influenced by various factors, with the first surge occurring after last September's mini-Budget, which initiated market uncertainty and led to a historic plunge in the value of the pound. Major lenders responded by withdrawing low-rate mortgage deals and reintroducing them to the market at higher prices, with this reduction in options making it challenging for borrowers to find favourable mortgage terms.  

While mortgage costs have experienced some correction since then, recent trends indicate a renewed surge in lenders raising the cost of deals, mirroring the relentless climb of the Bank rate in the face of elevated inflation. While many mortgage lenders had already accounted for the most recent rate rise in their pricing, a significant number continue to withdraw deals and increase the cost of fixed rates. 

In the U.K. Finance Minister, Jeremy Hunt has unveiled a government charter that has been agreed upon by banks, mortgage lenders, and the Financial Conduct Authority (FCA). These measures include temporary changes to mortgage terms in line with FCA rules such as switching to interest-only payments for six months and extensions to mortgage terms to reduce monthly payments. Both will be offered without affordability checks and the assurance that people’s credit scores won’t be negatively impacted. Moreover, recognising the potential risk of homeowners losing their homes, lenders have agreed to provide a 12-month grace period before initiating repossession without consent. 

We are now seeing lenders stepping up and proactively contacting customers to discuss support options, with the FCA seeing over 2 million customers receiving active support from lenders to manage their finances including budgeting tools, debt advice and mortgage forbearance.  

But this increase begs the question: how do lenders adapt to the evolving landscape of rising interest rates and what is the difference this time round? 

The challenges lenders face  

When interest rates rise, the valuation of equities held by firms declines, thereby reducing their net worth. This diminished net worth, in turn, reduces the amount of collateral firms can provide for their loans. With reduced collateral, firms become more vulnerable to potential losses, prompting lenders to adopt more cautious lending standards. To account for the increased risk, lenders charge higher interest rates, further raising borrowing costs. Consequently, this tighter lending environment leads to fewer loan approvals and a slower pace of lending for both consumers and businesses. 

The increasing interest rates have meant there have been significant adjustments that lenders managing mortgage loans have had to make, which have come with its fair share of challenges. One major hurdle is the frequency of interest rate changes, which creates a significant workload for lenders as they must update documents and communications to reflect these adjustments, meaning that the automation of processes to streamline operations is vital.  

Poor communication and engagement with customers due to mortgage changes can lead to dissatisfaction and hinder the loan servicing process. Establishing effective channels of communication and maintaining regular engagement is essential for a positive and streamlined borrower experience. Additionally, providing self-service options for customers is another area where lenders encounter challenges. Customers often require information such as settlement figures or annual statements, and the lack of self-service capabilities can result in increased manual efforts and customer frustration. 

The re-keying of information is a time-consuming task that lenders face, particularly during the application process. Streamlining data capture and prepopulating proposal documents for customers can alleviate this manual burden and create a better experience for borrowers. 

Managing different types of finance products and navigating the intricacies of their setup and administration pose additional challenges for lenders. Each product type may have its own unique requirements and nuances, and calculating interest and settlement figures can be complex, particularly when a variation of business models involves daily interest calculations and monthly capitalisation, necessitating careful attention and expertise to ensure accurate and efficient calculations. Furthermore, the origination of loans itself incurs costs for lenders, meaning they need to allocate resources for activities such as application processing, verification, and documentation, all of which contribute to the overall cost of lending. 

The dynamic nature of interest rates and terms necessitates the setting up of custom templates to accommodate these changes. Lenders must invest time and effort in creating templates that align with the evolving landscape, ensuring accuracy and compliance. Moreover, the time-consuming nature of document requests and capture further adds to the challenges faced by lenders. Efficient systems and streamlined processes can help minimise delays and improve operational efficiency. 

Understanding their portfolio of customers, assessing affordability, and addressing vulnerability poses additional challenges for lenders. They must ensure they have systems and processes in place to accurately evaluate customers' financial situations and ensure responsible lending practices.  

Manual efforts are required throughout the loan lifecycle, including servicing, administration, underwriting, and decision-making. Automating these processes can reduce errors, increase efficiency, and free up resources for other critical tasks. Overall, lenders must navigate a multitude of challenges in managing mortgage loans during periods of high-interest rates. Automation, streamlined processes, effective communication, and compliance measures are key areas that require attention to ensure smooth operations and customer satisfaction. 

Consumer Duty adds additional consideration 

Regulatory compliance presents a constant challenge for lenders and keeping up with evolving regulations and ensuring adherence can be resource-intensive and requires ongoing efforts.  

With the FCA’s Consumer Duty coming into play it will bring additional challenges to the industry and lenders. This regulatory framework aims to enhance consumer protection and promote fair treatment of customers, setting principles and standards that govern and monitor the behaviour and practices of financial institutions towards their customers. 

It will place greater accountability on financial institutions to ensure they prioritise the best interests of their customers and act with integrity in all their dealings. Financial firms are expected to prioritise their customer’s needs and deliver products and services that are suitable and appropriate. This includes providing clear and transparent information about customers’ options, avoiding conflicts of interest, and taking reasonable steps to prevent harm to customers. 

Lenders must also communicate with customers in a way that is clear, fair, and not misleading. They should provide information that is easy to understand, disclose all relevant terms and conditions, and avoid using language or practices that could confuse or mislead customers, alongside providing decent customer service. With these new regulations coming into effect, lenders will need to ensure they are taking Consumer Duty into consideration when adjusting their mortgage loan offerings.   

Lenders need the right tools to adapt  

In today's turbulent market, lenders face the challenge of adapting to the changing landscape. To thrive in this environment, lenders must carefully consider the tools at their disposal. One crucial aspect is utilising appropriate software solutions that offer a comprehensive view of affordability and vulnerability, enabling lenders to assess these factors before extending a loan. With rules-based decision-making capabilities, lenders can automate parts of the application process, allowing customers to securely provide essential mortgage information through digital platforms. 

It is also essential for lenders to partner with providers that cover the entire credit-to-debt cycle. These providers possess valuable insights into the challenges faced by lending, collections, and insolvency, equipping them to offer suitable solutions to navigate the evolving lending market. By understanding the needs of lenders and their customers, these providers can offer lending software that streamlines the user journey and manages client communications; simplifying and enhancing the entire credit journey, making it more efficient for all parties involved. 

Through the adoption of such software solutions, lenders can streamline processes by automating numerous manual tasks, leading to improved decision-making. This automation expedites the mortgage loan application process, benefiting both lenders and borrowers alike. With the right software in place, lenders can adapt to the changing landscape, make informed decisions, and provide a faster, more efficient lending experience for their customers during these difficult times.