As the cost of living and interest rates rise, how does this impact self-employed dentists and their mortgages? asks Vinay Rathod of VR Financial Solutions.
Self employed dentists and those operating under a LTD Company have often faced difficulties when applying for a mortgage.
Recent increases in the cost of living and the Bank of England Base Rate (BBR) have had considerable impacts to how lenders view applicants, especially those who are not employed with PAYE income.
For many years, self employed dentists have faced scrutiny of their accounts, often requiring two to three years of accounts before being able to maximise borrowing potential and get the most competitive rates.
If you have changed from being self employed to trading under a LTD Company you may have found it difficult until you have two full years of accounts under the new company.
Even then, many will have found borrowing limited by their relatively low salary and dividend drawings. I should highlight that there are options to overcome all of the aforementioned obstacles.
This has become even more difficult as a result of the pandemic, and even worse still following Kwarteng and Truss’s mini budget on 23 September 2022.
Following the budget, the financial sector was aghast with announcements that were contrary to anything expected by even the outliers.
Huge uncertainty was quickly followed by huge volatility as financial institutions desperately tried to protect themselves from what might happen – and for once, nobody had any idea what that might be.
The announcements were so contrary to anything expected, and to anything experts all agreed was in desperate need.
When uncertainty exists, people and businesses seek to protect themselves – we enter a state of defensiveness because, human nature is to seek consistency, certainty and avoid the unknown. Financial markets are no different – they crave stability and predictability.
When this is not present, banks and lending institutions favour over cautiousness to growth and profits.
It wasn’t until Rishi Sunak was confirmed to replace Liz Truss that there was any relief felt in the financial sector.
I will try to remain politically impartial in this article, however Sunak’s background working for investment bank Goldman Sachs and various hedge funds, as well as his education in economics, offered some hope of recovery of our fragile economy.
Sunak had even been recorded predicting what we witnessed, months before when debating Truss.
If anybody touted as our future PM could give us back some stability, the financial sector believed Sunak was our man.
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How do banks price mortgage products?
Firstly, we must understand where the money actually comes from. Banks do not lend their own money They lend a combination of their customers money, and money borrowed from wholesale financial markets in the form of various complicated financial products.
It was not until the financial crisis of 2007/8 that there were any real rules governing how much capital a bank must possess versus the money they lend.
It was a poor ratio of this very measure that contributed heavily to the 2007-2008 financial crisis. Even now, capital adequacy rules are far from requiring banks to have an equal amount of capital vs. their credit risk exposure.
So then how do banks decide what interest rate to charge to you? Many believe that the interest rates that we pay, are linked somehow to the Bank of England’s Base Rate (BBR).
Historically, you can even see that this has largely been an assumption that you will see to be true.
It is in fact however, the LIBOR (London Interbank Offered Rate) that has historically been the measure used to price many financial products, the most widely recognised being mortgages.
Even this has largely been phased out due to its contribution to the 2008 financial crisis and more recent manipulation of the LIBOR rate by some banks, and replaced by SONIA (Sterling Overnight Index Average).
Back to 23 September last year. The financial market’s concerns resulted in the worry of huge increases in the LIBOR/SONIA rate.
This prediction of future LIBOR/SONIA changes is measured by ‘swap rates’. The swap rate determines the markets estimates of future changes in this rate.
Following the mini budget you can see a step away from the normal and desired slight changes we normally see.
Banks did not know what it would cost them to lend money. They feared they could make losses on mortgages if they didn’t overcautiously raise rates quickly.
This was more than 6% for many, and smaller building societies and money lenders pulled from the market entirely, taking on no new applications.
Lenders ramped up their stress testing – worrying even more because of the rising cost of energy soon being fully exposed to the public when the domestic price cap ends (more doom and gloom I know).
They reduced income multiples and those banks willing to be flexible and negotiate bespoke terms for certain applicants (dentists) started saying no.
This meant more difficulty maximising your borrowing ability, smaller maximum loans, budgets for new homes forced to be reduced and remortgaging made more difficult.
Fast forward to 25 October 2022 and we welcome Rishi Sunak as Liz Truss steps down. Financial markets feel hopeful of recovery under the control of a fellow financial expert.
The man to make unpopular decisions was brought in to reverse almost all of Kwarteng’s measures. Never before was I relieved to know Hunt would be making difficult decisions – a person who clearly doesn’t care about being popular.
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Life after Trussonomics
Confidence brought us stability. Stability meant more certainty. Certainty gave us cheaper mortgages.
We now understand that, despite the Bank of England continuing to increase interest rates in the hope to grasp some control of the runaway train that is inflation, mortgage rates have been consistently coming down.
We have a long way to go. In fact, we are likely never to see the kind of interest rates offered to borrowers a year ago – rates fixed at well below 2%.
But thankfully we are far from the 6% and are back in the less worrying 4 and 5% range – and even for those with a hefty deposit / equity – sub 4%. I am optimistic that we will see more rates in the threes again in the not too distant future.
Rarely has a day passed since October where I don’t have at least one lender email us regarding an incoming rate reduction. Yes, they are slight, but a little does add up to a lot given time.
Those lenders who stopped lending have largely returned – maybe not quite back to business as usual, but they’re already planning for it!
This is something they couldn’t think about just three to four months ago.
The lenders who will allow negotiation are coming back to their seats at the table, and we are hearing that delightful word more – yes!
Maximum loans are still impacted due to the cost of living expected still to rise. Those remortgaging will almost certainly have to tighten their belts a little for a couple of years.
But within dentistry we remain fortunate, for the majority income exceeds committed outgoings with some to spare. Tightening belts is not something too uncomfortable for most.
For those whose businesses have boomed during the pandemic, you may now just have a little less to put away than you used to.
But we have long been spoilt with rock bottom interest rates to borrow money. We have long been too easily able to raise low cost finance resulting in being maybe slightly unrealistic of how much money costs to borrow.
I think we should get used to money being less easily available, and not quite so cheap to borrow. The days of mortgage rates in the one percent range are likely long behind us.
VR Financial solutions have a considerable amount of expertise in arranging mortgages for dentists, having consulted lenders and assisted in lending policy being established and improved for self-employed dentists.
We work closely with many lenders and have established close relationships to allow us to negotiate and overcome many of the troubles being self employed result in.
At an uncertain time like this, it’s more important than ever to take professional advice.
By Vinay Rathod