Background

The recent challenges brought about by rampant inflation, causing interest rates to be rapidly escalated in the UK and some other economies is bringing pain to the UK housing and mortgage market.  What we are seeing are remedies used in the 1980’s when 70% of people owned their own homes, with 80% of people on variable rate mortgages.  In 2023 only 62% own their own home with 80 % on fixed rates. This means that the interest rate remedy will take longer to work and will impact in a random way those who are unlucky to be coming to the end of their fixed rate deal.

In the low interest rate environment from 2008 to 2022, only experts needed to understand lender funding models, hedging strategies and pipeline management processes.  Since we entered a higher inflation environment, with volatile interest rates and sudden product withdrawals, these topics have become important for everyone to understand.

Mortgage funding is not just about raising deposits to lend out to borrowers, which is how traditional building societies worked until the mid-1980s. Then, borrowers waited in a ‘mortgage queue’ until the society accumulated sufficient funds from savers to lend out as mortgages. Modern lending works differently with more sources of funding.

In essence, lenders make profit by ‘borrowing’ from savers and investors and lending to other customers in the form of mortgages and loans. The lender charges the borrowers interest, passes some of this to its savers and keeps the rest to cover its costs and return value to shareholders or members.

Without alternative funding, lenders could run into cashflow difficulties, as they can’t control the timing of inflows and outflows so that everything remains in sync. They need to protect themselves from volatile interest rates. If lenders get their funding models wrong, they risk making significant losses – or in the worst-case scenario, becoming insolvent.