Despite recent evidence that house prices might have bounced this year, mortgage lending doesn’t seem to have revived – the Council of Mortgage Lenders’ August 2009 figures show a 37 per cent year-on-year fall.  The August total also represents a 13 per cent month-on-month decline, so it seems the summer bounce has ended early.

The FSA Q2 Mortgage Lending and Administration Returns show the same picture; there was a one per cent increase in total loans outstanding, but new advances were well down. New advances in the quarter were £33 billion, £1 billion up on the previous quarter – but more than halved from £72 billion in the second quarter of 2008. That’s way down from the peak level of lending – £102 billion, in the third quarter of 2007.

However, looking at the detail of the August CML figures, they don’t seem quite such bad news for the housing market as at first appears. pThe fall is largely due to remortgage business – and for the first time, new lending for house purchase accounts for over 50 per cent of total lending in the month.

Remortgages are falling because borrowers prefer to stay on lenders’ Standard Variable Rate (SVR), where they are low. Borrowers have little to gain by fixing, with many fixes above the best SVRs – so why should they pay an arrangement fee for a new mortgage, while staying on SVR costs them nothing?

Since house prices have fallen dramatically, borrowers who originally borrowed 75 per cent of their purchase price may now find they need to borrow 90 per cent of their property’s value – disqualifying them from the best mortgage offers. Also lenders’ criteria have tightened – so that lending at a loan-to-value of over 90 per cent, which was as high as 15 per cent of all loans in early 2007, has shrunk to under three per cent.

Mortgage products down 90%

The supply of mortgage products has definitely declined – though again, it seems there’s been a small improvement since earlier this year. Moneyfacts says that the total number of mortgage products available bottomed out at 1,209 on 1 April this year – a 90 per cent drop from the peak of almost 12,000 products that were available in July 2007. There are now 1,392.

But the decline is much greater for some products. Moneysupermarket.com says the number of tracker mortgages available fell 81 per cent in the twelve months to July 2009, against only a 59 per cent decline in the total number of all mortgage products.

Lenders have trimmed the amount of their loan book which is exposed to variable rates. Louise Cuming, head of mortgages at Moneysupermarket.com says, “Banks which had a large number of tracker mortgages on their books have had their fingers burnt by the dramatic fall in the base rate.”

Longer term fixes are disappearing, too, despite government promotion of the idea of longer fixes. In July, Manchester Building Society withdrew the last 25 year fix. In January 2008 these products – now there are none and only one 15-year deal (from Britannia Building Society). Providers and brokers alike prefer the frequent turnover that comes from refinancing of shorter term deals.

A two tier market

Another interesting factor has been the development of a two tier market. Brokers are seeing a continued drop in the number of products available to them, according to mortgage sourcing service Trigold Crystal. The average number of live products available to intermediaries fell from 2,610 in June to 2,202 in July – a reduction of 408 individual products, or six per cent. Mortgage product availability had dropped significantly compared to a year earlier – with 13,464 products available in July 2008, and 64,803 in July 2007. Broker activity has been falling too, with July seeing a drop of 14.8 per cent compared to a month earlier. Again, while the month-on-month drop doesn’t look too bad; the year-on-year comparison is much worse – that’s a 47 per cent drop in broker activity from July 2008.

David Aylmer, marketing and business development director at TrigoldCrystal, said, “Product availability continues to be one of the central issues in the mortgage sector. What should also be of interest to brokers is the increase in the number of ‘direct only’ products which have been increasing since April this year.”

Lenders are not only trimming their product portfolios, and attempting to rebalance their mortgage books towards shorter fixed rate products, but also attempting to keep increased amounts of business – and of margin – for themselves.

That’s bad news for consumers – because the mortgage marketplace isn’t getting any easier to navigate. The Moneyfacts Treasury Report on UK Mortgage Trends in July showed shelf lives of mortgage products are shortening. Despite the fact the base rate has remained stable since March, swap rates and mortgage interest rates have continued to be volatile, forcing lenders to adjust their product ranges regularly. The average shelf life shortened from 23 days to just 14 days in June 2009; that doesn’t give borrowers much chance of finding the right product without using a broker.

A mortgage on their terms only

Lenders are also continuing to impose tight restrictions on borrowers. The availability of funds may be less tight than was the case earlier in the year – 90 per cent loan-to-value mortgages have become available again, for instance – but the price has definitely increased for borrowers without a large deposit or good credit record. The cheapest mortgage rates and top products in the market, are only available at 60 per cent loan-to-value. Moneyfacts showed the number of new mortgages requiring a 40 per cent deposit had increased 61 per cent in the six months to May 2009 – practically the only sector of the market to show growth! The number of mortgages available to borrowers with only a 10 per cent deposit had fallen two-thirds in the same period. So only borrowers with a huge deposit – at current average house prices, that’s nearly £90,000 – can take advantage of the best rates.

The divergence between the best and worst rates available has also increased. While the rates on a 60 per cent loan had fallen 1.63 per cent from November 2008 to May 2009, the rates on a 90 per cent loan had fallen only 0.74 per cent – increasing the spread dramatically. In other words, lenders are applying risk pricing in such a way as to choke off all but the best quality demand.

Michelle Slade, spokesperson at Moneyfacts, says, “The market remains dominated by deals for those borrowers with at least a 25 per cent deposit as lenders look to cherry-pick the best customers.” Customers with only a 10 per cent deposit will end up paying a rate two per cent higher than those who can put up forty per cent in cash.

That’s not necessarily a healthy situation – Louise Cuming says the polarisation of mortgage offers is now holding the market back. “Providers must look to offer affordable deals for all borrowers including those with smaller deposits,” she warns, “if the mortgage market is to make a full recovery.” But it seems unlikely that lenders will unfreeze their credit policies until they have more confidence in the economy – and until they see their own capital ratios improving.

At the same time as the credit screw has been tightened, arrangement fees and penalties have become more significant. For instance, the Woolwich offers a one year fix at the exceptional rate of 1.98 per cent, but it’s only available on mortgages of £200,000 or more, with 60 per cent loan to value. It also has a £999 fee, and it has a penalty if repaid within the first three years at two per cent of the total amount. Arrangement fees on many products are now in excess of £1,000.

Deal or no deal?

Hannah-Mercedes Skenfield, mortgage spokesperson at Moneysupermarket.com, says, “Even the most generous lenders have drastically increased their margins.” She points to the fact that one of the best deals recently was First Direct offering 2.29 per cent over the base rate – two years ago, Yorkshire Building Society was offering 0.76 per cent below the base rate.

The margin between the average two year fixed mortgage at 5.18 per cent and the two year swap rate – the rate most lenders will be paying on their funds - at 2.04 per cent at the end of August was the widest on record. For building societies which fund their lending book from deposits, the margin between savings rates (with the average account at 0.84 per cent, and fixes at 3.42 per cent) and lending is also the widest ever.

Michelle Slade of Moneyfacts says, “Margins continue to be increased as lenders look to repair dented balance sheets. Normal rules, where lenders pass on or decrease rates based on the cost of funding, seem to have well and truly gone out of the window.” She makes the point that customers looking for a new deal are subsidising existing customers on low rate SVR or tracker deals.

Moneysupermarket.com also points out that though the average rate for new borrowers has fallen, it hasn’t fallen as fast as the base rate. There’s also much more difference between the best rate available and other mortgage offers on the market. The divergence between the best rate and others is now 2.5 per cent, against just 0.93 per cent in 2008 – so even in this restricted market, it pays to shop around.

Louise Cuming says, “We have seen the margin between average mortgage rates and the LIBOR rate creep up – lenders are benefiting from the fact that demand for mortgages outstrips the supply.”

Buy to Let – even tougher

While life is tough for residential mortgage customers, it’s even tougher for buy-to-let investors. CML stats show that new buy-to-let loans fell four per cent in Q2. In the comparable period in 2008, buy-tolet accounted for 12 per cent of all mortgages – that’s now halved.

The buy-to-let market has always been heavily reliant on wholesale funding – few of the building societies have been much involved – so the credit crunch has hit it hard. CML senior policy adviser Rob Thomas says, “new lending to the buy-to-let market will continue to be constrained by the shortage of funding.” Lenders simply cannot take a unilateral decision to free up lending.

So it’s the supply side that is responsible for the tight market. Moneysupermarket. com says borrowers are keen to get stuck in and buy residential properties at high yields – buy to let enquiries have increased 50 per cent in the year to August 2009. But the number of products available has fallen 70 per cent over the same period.

At the same time, loan criteria continue to tighten. Loan-to-value has tightened from 85 per cent to 75 per cent on most loans, and lenders have reduced their terms for multiple landlords. Paragon Mortgages research shows that nine out of ten residential landlords who have applied for a mortgage recently think it has become more difficult in the last three months. John Heron, Paragon Mortgages’ managing director, said, “Product availability in the general mortgage market has improved slightly in recent months, but has worsened for the buy-to-let market. Mainstream lenders are reducing their focus on this sector and specialist lenders are still unable to access the wholesale funding markets to enable them to offer new products.”

Even worse news for existing buy-to-let investors is the fact that a number of lenders are now setting SVRs artificially high in a deliberate attempt to force their borrowers to remortgage elsewhere. Reducing the buy-to-let mortgage book has become a key strategy for many lenders who perhaps were not well advised to get involved in this market in the first place – but the landlords are caught in the crossfire.

Buyers are still not out of the woods

While mortgage product availability and gross lending don’t appear to be shrinking as fast as they have done over the last two years, we’re obviously not out of the woods yet. Lenders are still in balance sheet reduction mode – attempting to limit their liabilities rather than to grow their share of mortgage business – and until they start to think more ambitiously again, the availability of credit for house buying looks likely to remain limited.