Mortgages for first time buyers
Recognising the potential of inter-connected systems and data sharing, how can we re-imagine the process for first time buyers and where do Banks fit in?
Authors
This is output from our monthly Scenario Thinking sessions, where we challenge our consulting teams to re-imagine aspects of the Financial Services sector for the future.
Buying a house is stressful
As a first-time buyer you need to navigate a multitude of challenges from legal paperwork, proving source of funds and getting the mortgage itself. Therefore in this article we look to recognise the potential of inter-connected systems, data sharing and distributed ledger technology and how they can improve the process for first time buyers.
For many first time buyers it can be a daunting task to just understand the process of purchasing their first house let alone going through the process. Therefore in a world where greater connectivity between financial firms and fintech firms is becoming normal, we ask if there is not a better approach.
We begin by looking at the current process a first time buyer must go through and the current state of the first time buyer market, and then examine possible ways to improve the process using distributed ledgers (the technology behind Blockchain).
Overview of the first time buyer process
1. Save Deposit
Banks typically require over 10% as a deposit, especially in the current environment. In March 2020, there were 446 mortgage deals for 10% deposits but by August 2020 there were just 34 available. Additional costs such as survey fees, legal fees, insurance and tax must be considered. Then the first time buyer goes through a soft or hard credit report to assess eligibility for a mortgage in principle as well as evidencing the source of the savings. Having passed these tests, the first time buyer is granted approval in principle.
2. Identify Budget & Agree Mortgage
When the first time buyer identifies a property within budget she applies for the actual mortgage. Her lender performs a full financial check requiring evidence of both income and expenditure. The lender gathers data from the borrower, credit bureaus, her employer and the public domain. At this stage first time buyers have the advantage of not being in a selling chain, which made a big difference in the 2019 pre-Covid mortgage market when first time buyers accounted for 51% of total mortgage applications in the year, the highest since 2007.
3. Close Deal
Once the buyer and seller agrees to a price, a conveyancer and solicitor ensure the property and contracts are in order. First time buyers often incur additional expenditure they were not expecting such as insurance, tax and fees. Sometimes, Government initiatives provide first time buyers with low or no stamp duty and lifetime ISAs. However, affordability in the UK and especially London has deteriorated contributing to declining ownership rates as low as 63%, levels last seen in the 1980s.
The current state of the first time buyer market
AVERAGE UK FIRST TIME BUYER PROFILE AS OF DECEMBER 2020
63% of first time buyers found their mortgage online and 50% applied for the mortgage online. Approximately 85% of first time buyers still receive a mortgage from the main high street banks. Many banks have a digital mortgage application front end, but the middle and back office processes are still carried out manually and/or have a low straight through processing rate. This can include processing applications, performing initial customer background check and manually underwriting the loan.
The UK mortgage market has lagged behind other areas of financial services in adopting new technology. While other sectors have embraced innovation, offering seamless instant experiences, the end-to-end mortgage and home buying experience is still slow and out of touch with customer expectations. Overall the process can take between 4 and 6 weeks to complete.
Despite the entry of a number of mortgage fintech’s into the market (e.g. Molo, Habito and Landbay), they have yet to make an impact. They claim a more digitized and faster mortgage application and processing model, taking 2 weeks on average, including:
Automated document classification
Data extraction and information validation
Semi-automated underwriting process in which the platform gathers credit history and checks credit scores
Semi-automated analysis of financial data and affordability
We are unaware of any mortgage fintechs that fully automate the approval of a mortgage without the need for manual intervention.
Full automation of the mortgage application and purchase process
We believe that distributed ledger technology can be used to improve the front to back mortgage application process. The main factor in delays to mortgage application processing is that there are multiple different actors involved who don’t always have a clear and consistent picture about what the next step in the mortgage application is: borrower, lender, surveyor, solicitor, estate agent, valuer, architect, etc.
With no clear visibility on status, it is easy to see how delays happen:
The borrower does not know that the bank requires additional documentation.
They surveyor does not know that the property is ready for survey.
The solicitor does not know that the mortgage has been approved and does not request the deeds in time.
Distributed ledgers are good at providing different actors with visibility on the status of a transaction and ‘next best action’ is always known. The way in which they work for Blockchain is extended to cover mortgage application processing in the example shown.
First Time Buyer
Step 1: Digital application submission
The first time buyer populates the mortgage application online, probably using a mobile device. The data entry includes basic information about the borrower and enables:
Scanning of ID and proof of address documentation
Upload of supporting documentation like current account and credit card statements, proof of deposit, parental guarantee if needed, etc.
Details of the property being purchased
Consent for the mortgage lender to collect data from and about the applicant
All of this information is stored against the mortgage application on a distributed ledger to which the actors have appropriate access.
Step 2: Initial checks and data collection
The distributed ledger enabled mortgage application system performs initial completeness checks against the distributed ledger to validate the completeness of the application and uses APIs and automated emails to collect data covering:
The borrower’s credit history
The borrower’s credit scores
Validation of financial information submitted
Criminality check
Employment details and references
Step 3: Data analysis and decision made
The mortgage application system uses AI, statistical analysis and predictive modelling to analyse spending patterns, wider financial health, income trends, DTI ratio and the likelihood of repayment against the lender’s lending criteria.
The output is a lending decision (i.e. not just a decision in principle) as follows
Green = auto-approve application
Red = auto-decline application
Amber = unclear result, human intervention is required to make a decision.
Over time, the automated analysis and modelling improves / learns to minimise the number of amber cases which require manual intervention.
Step 4: Payment of Loan and Settlement
The approved mortgage application becomes the first ‘block’ in the distributed blockchain. The solicitor, valuer, and other actors can see the mortgage is approved and act quickly to complete their actions (legal contract and valuation report) which can be uploaded into the distributed ledger as more blocks. The buyer can then use an encrypted key to sign the offer, and the buyer’s signature becomes the next block. Finally the funds transfer and transfer of the deed become their own blocks to complete the mortgage transaction.
What would this mean for first-time buyers?
Streamlined application process - More aligned to modern consumer expectations allowing for moving times to be as approval/rejection is less than a week long.
Real-time application tracking - With everything being completed through one platform it can provide holistic view on status of each stage.
Detailed breakdown of Success – Customer by customer approach allows reporting to show customers exactly why they were successful/unsuccessful
Lower costs - Process involving less third parties meaning for less additional fees overall.
Better data – Although the data gathered from the customers and their third parties is what allows for the reduction in cost and increase in speed of the process, it also provides the bank with far more customer centric data to leverage across the banks’ offerings.
Improved security – With the use of distributed ledger technology as well as a far more sophisticated credit scoring system the chances for irresponsible lending or fraud dramatically drops.
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