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Do you expect to see less or more second charge mortgage lenders in 2018?



Is packaging first and second charge mortgages just the same?

By Paul Woodworth, Managing Director of Gateway2Finance |


 How many times have we heard that in the past few weeks? And for me, there lies the issue.

How many times have we heard that in the past few weeks? And for me, there lies the issue.

Many mortgage advisers believe that second charge mortgages are similar products to first charge mortgages only for smaller amounts with higher interest rates and inflated packaging costs.

So I thought it might be worthwhile pointing out some of the differences between the two products and explaining why this comparison is not currently a fair one.

Loan amount, term and rates

Smaller loan amounts, shorter terms and higher rates are part and parcel of the second’s product and should not be directly compared with first charge mortgages. The average life of a first mortgage compared to a second differs considerably, as does the risk profile. Second charge lender forecasting and profit and loss models are completely different to firsts as origination costs have to be recouped over a much shorter time. Also, as second charge sits behind first mortgages there is a greater risk exposure to losses should the borrower default. Both of which must be factored in to the rate calculation.

Funding

Most mainstream first mortgages are retained on the lenders balance sheet. Granted some of the more complex first charge lenders will look to sell or securitise mortgage portfolios, but this is still a small proportion of the overall number of first mortgages originated. The second’s model, however, is different with most lenders looking to securitise at some point in the future. This will mean that second charge lenders will be more pedantic over paperwork as they need to ensure that all loans generated will form part of any future securitisation. Loans that do not qualify may have to be retained on the originating lenders balance sheet, and they don’t like it when that happens!

Packaging costs

Having packaged both first and second charge mortgages, I am of the opinion that the packaging of seconds requires a greater element of underwriting knowledge than with firsts. Lenders provide more in-depth criteria and expect underwriters to understand, interpret and comply with their specific lending guidelines, especially around areas such as affordability, bureau data and Land Registry searches. The majority of this work is carried out by the lender or a legal representative within the firsts market.

The first charge mortgage contract can also pose challenges in itself. For example, dealing with offset mortgages and deeds of postponement to name just two.

It can, therefore, be argued that the packaging of second charge mortgages can in many cases be more complex than that of firsts.

Commercials

The cost of processing a second is at least equal to the cost of processing a first. So if we assume that packaging costs is basically a manufacturing cost, why are fees so high?

One major reason is that of acquisition. Master brokers have often worked to a model whereby the introducing mortgage adviser receives between 50% and 55% of the net income generated from the loan. This is at no risk to themselves (no outlay) and the master broker has in the past absorbed all abortive costs.

I haven’t heard one master broker complain about this as it is the model we have worked to for many years, but unlikely to work to in the future. However, if mortgage advisers were to actually take the time to work through the figures, they would see that master brokers are not earning the massive margins that the market tends to portray.

So not the same!

The majority of master brokers welcome the changes as they provide greater flexibility around charging structures. The move away from the constraints of the Consumer Credit Act permits these costs to be paid up front reducing the exposure to abortive costs as has been the case in the past.

The overall aim of the regulator and those operating within the industry has to be to align first and second charge mortgages. However, right now the products, funding lines, servicing of loan books and commercial models are quite different.

Alignment will take time as customers and introducers gain confidence in the product and there is a clearer understanding of how the whole chain works, not just the sales and packaging models. 



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