Looking ahead to the rest of 2018, I realise it’s easy to end up feeling a bit Donald Rumsfeld. The known knowns, the known unknowns and the unknown unknowns all loom large in our Brexit-aimed economy.
One significant “known unknown” for the lending markets is the known move from an ultra-low interest rate environment to a higher rate one – but how far and how fast rates will rise is unknown. How it will affect the bridging market is also broadly unknown, and the factors here become more complex depending on how bridging lenders are funded.
The rate rise last November had many people feeling that it could be followed by several more. It is more likely that there may be only one other rise this year, but the significance is that it has marked the shift to a rate rise environment other than the static one that we have become accustomed to over the past ten years.
In the rate-sensitive mainstream mortgage market, higher rates generally mean more defaults and there is bound to be an element of payment shock, especially amongst those who had never experienced a rate rise until last November. There are also knock-on impacts for risk and affordability assessments, as well as for property prices.
Rates matter in the short term lending market too, but there are good reasons to see bridging as slightly less rate-sensitive in terms of loan demand and performance. This is partly because rates usually do not rise during the loan term. Additionally, lenders are funded differently; only a proportion of bridging lenders are reliant on external funding, while others like Hope Capital are privately funded so are not directly affected by the Bank of England rate rise.
As the bridging market has become more popular, competition has lowered rates by two or three per cent or sometimes more over the past year, causing a dichotomy between rising mainstream rates and falling ones in short term lending. Rates differ widely from lender to lender according to the degree of service, speed, flexibility and risk required.
Rates have dropped again this January as a mini price war takes hold in the bridging market, mirroring what happened last year, as short term lenders strive to kick start the year on a high. As the previous few years have reflected however, the bridging market is typically less price sensitive than the mainstream mortgage market. This is particularly the case amongst developers and other borrowers with slightly more complex requirements. While everyone wants the lowest rate possible, often achieving completion in just a few days, or obtaining lending in more complex circumstances will take priority over rate. As a result, modestly higher rates would be unlikely to dampen demand significantly.
Where borrowers will be most affected is if their exit route is a refinance onto a longer term mortgage which now has a higher rate. One of the things that all bridging lenders need to be sensitive to is how the prospect of higher rates may affect customers’ exit strategies; we need to know with a high degree of confidence how the customer plans to repay.
For most customers, the exit strategy means either sale of the asset or refinancing to a long term lender. Both these things potentially become harder if rates are much higher. This will be especially true for those bridging lenders who lend to home-owners, where the requirements of MCOB affordability assessment and stress testing must inevitably bite.
But even in unregulated or commercial bridging, exit strategies are potentially going to need more scrutiny if we move to a rising rate environment. Higher rates mean higher debt servicing burdens and softer property price growth, which will tend to dampen the market. On the other hand, rising rates are also an indicator of an improving economy – so with earnings and business investment potentially rising, there is a more positive side to the same coin.
Overall, assuming that rates rise only in baby steps, I don’t expect the impact on bridging to be dramatic. Hope Capital’s funding position enables us to assess applications speedily and decisively, while still looking at every case on an individual basis and this will not change under a rising rate environment. Whether this will be true across the bridging market as a whole remains to be seen.