Even Banks Have to Budget for Home Loans
It's something you hear if you're in the market for a home loan: you have to work your budget to make sure you can afford it. Good budgeting is a fundamental part of sound borrowing. So would you be surprised to know that banks have to do something similar? Indeed, they also need to budget for home loans as well. The only difference is that they have to include the potential of large-scale defaults in their budgets where consumers only need to worry about whether they can repay or not.
Recent news reports showed just how important budgeting is for banks and building societies. Apparently, Nationwide set aside some Â£9 million last year to cover any losses that might arise from home loan defaults. That Â£9 million was added to Â£34 million the nation's leading building society realised from its commercial properties. But even that amazing Â£43 million amount was dwarfed by the Â£111 million Nationwide set aside for 2017.
Provisional Funds against Defaults
When consumers go to banks and building societies to get home loans, lenders need to know that they have the income to support borrowing. Banks have to do the same thing when lending. They need to be able to have enough cash flow to not only support what they are lending but to also absorb losses realised when customers default. Furthermore, they must be able to demonstrate their cash flow in such a way as to satisfy regulators and their own balance sheets. That's not necessarily the easiest thing to do.
The setting aside of provisional funds is as critical to a bank success as savings accounts are to consumers. Imagine a building society as large as Nationwide dealing with just 100 consumers defaulting on mortgages of Â£100,000. The losses from those mortgages alone would amount to Â£10 million before court costs. If those 100 customers become 1000, Nationwide would have already exceeded their provisional funds when court costs are factored in.
It's important to note that regulations require banks and building societies to set aside provisional funds. In other words, the government forces them to save a little extra, just in case. Those provisional funds provide somewhat of a safety net designed to protect banks against full-scale failure.
What the Nationwide Move Means
So, just what does the Nationwide move to set aside Â£111 million actually mean? It means that the building society generally agrees with the Bank of England that our economy is headed for a slowdown over the next 12 to 24 months. They are not expecting a crisis similar to what we saw in 2008, as the amount the set-aside is just a fraction of their total loan book. Nonetheless, they do expect the number of defaults to rise as the economy slows.
Let's hope their forecasts for the future turn out to be wrong. We don't need another economic downturn. But if the downturn actually occurs, it wouldn't be all bad for consumers looking for home loans. Economic downturns tend to improve interest rates and terms for consumers who have decent credit and enough income to support their borrowing needs. Home loans could be at their very best a couple of years from now if things work out just right.
So now you know that banks and building societies have to budget for home loans every bit as much as the consumers who borrow from them. Maybe that will make the borrowing process a little easier for you to cope with next time you're in the market for a home loan.
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