With falling energy prices, economists are forecasting that the UK’s inflation rate will have fallen to 5% by the end of 2023.

Whilst this should be a welcome relief to UK consumers, many will still be feeling the pinch from higher prices, particularly from the effect of food price inflation (17.3% in June 2023) and mortgage interest rates; fixed mortgage rates are between 6 and 7%, their highest in 15 years.

The implication for mortgage borrowers is predictable. With the fall in net disposable income, discretionary spend will be squeezed, and for some, mortgage payments on current terms cannot be met.

Regulatory guidance

In March 2023, the FCA issued its Guidance Note, FG23/2: “Guidance for firms supporting existing mortgage borrowers impacted by rising living costs.” This directed lenders to offer customers experiencing, or expected to experience, financial difficulties arising from the cost-of-living crisis “protected forbearance”. The guidance suggests that lenders should consider varying the terms of customers’ mortgages to enable them to “avoid, reduce or manage” any payment shortfall that would otherwise arise. The measures could include:

• Switching a repayment mortgage into a (cheaper) interest-only mortgage for all or part of its terms
• Extending the mortgage term into (or further into) retirement. In doing so the FCA has confirmed that aspects of existing suitability rules, as detailed under MCOB, can be disregarded where forbearance is required:
• There is no need to assess affordability.
• For switches to an interest-only mortgage (on a temporary basis), this can be done without the need to evidence a clearly understood and credible repayment strategy. Such a variation would not be considered appropriate or temporary if, after the temporary period is over, the customer is not obliged to make payments of interest and capital that would fully repay the mortgage over the remaining term. If the mortgage is to permanently switch to an interest-only basis, a credible repayment strategy would then be expected.

Notwithstanding these requirements, we anticipate that the repayment challenges for some mortgage holders will not be temporary. An increase in enforcement action is expected. Indeed, in some scenarios, allowing arrears to accumulate and grow will only exasperate customers’ debt position.

Debt consolidation drawbacks

As inflation eats into customer’s new disposable income, some may see the consolidation of debt onto the secured mortgage debt as a natural solution. Interest on unsecured loans, particularly credit card debt, can be significant and far higher than mortgage repayment interest and can offer the comfort of immediate relief on net disposable income.

However, there are dangers with such debt consolidation:

• An unsecured debt now becomes secured. For (smaller) unsecured debts, missed payments would have had relatively little significance; the likelihood of court action to retrieve the defaulted debt is low. However, incurring arrears on mortgage repayments would put the customer at risk of enforcement action and repossession.
• Whilst short-term repayment costs may be reduced, the total cost of repaying the loan over the mortgage term could be higher, and significantly so bearing in mind current interest rate levels. The necessity of consolidating the unsecured debt to the mortgage becomes questionable if the customer has ample disposable income to meet the debt over a relatively short period.

Objective advice

There may be a temptation for a mortgage adviser to simply meet a client’s desire and facilitate an increase in net disposable income through debt consolidation. It’s imperative that advisers give customers a comprehensive comparison of potential costs so that they fully understand the true costs of the status quo versus consolidation. In addition, the mortgage adviser must remember that their role is to advise and to ensure a good outcome, even if that means their recommendation going against the client’s desired course of action.

Need advice?

TCC can provide independent review and challenge through:

• A review of mortgage forbearance policy and procedures
• A review of arrears management, including a review of sample cases
• A check of compliance against FG23/2
• Review complaints and facilitate root cause analysis

Learn more about how TCC’s experts are helping financial services firms achieve regulatory compliance in these economically challenging times. Get in touch today.