Never mind the discounts - where's the comfort factor?

MORTGAGES

Another month and another dismal set of home lending figures. Total mortgage approvals fell by almost a quarter to 61,000 in April from 78,000 in March, suggesting that they are losing the battle in the intensive care ward of the economy.

If anything the patient's condition appears to have deteriorated from "critical but stable" to "critical". Neither is the prognosis encouraging. Attempts at resuscitation using the cut-price mortgage technique have so far failed to raise a single blip on the screen and the house price thermometer continues to drop.

This time lenders are blaming fears of an interest rate rise that did not happen. But there is also an acute awareness that price is not the only factor when it comes to mortgages and that the underlying loan package will have to be modified if the homebuyer is to resurface in an uncertain labour market.

With the Government either unwilling or unable to help, the mortgage lenders must do it themselves or see business dry up altogether. That means putting an end to the inflexibility of the traditional British mortgage by allowing borrowers to easily reduce or halt their monthly mortgage payments during periods of unemployment and to increase them in periods of prosperity.

"Mortgage lenders must be able to cope with periods of unemployment amongst borrowers or else disqualify a large number of households from becoming owner occupiers," John Massey, head of mortgage services at Midland Bank, said.

Most lenders are already developing new, more flexible, packages that will cater for repayment holidays. These are likely to be actively marketed towards the end of the year in attempt to restore confidence, which lenders say has been savaged by government plans to reduce the amount of income support to be paid to unemployed homeowners from 1 October.

This week Abbey National became the first big lender to introduce a so called "repayment holiday" mortgage. Available only on the bank's standard rate of 8.34 per cent, it allows borrowers one interest-free month a year for the first five years, to be taken in December.

Of course, it is already possible to reduce monthly payments by extending the term of a repayment mortgage or negotiating interest-only payments for a while. Similarly, you can alter the level of contributions to a personal equity plan mortgage. But endowment and pension mortgages are less flexible because it is impossible, or does not pay, to cash in the underlying investment vehicle.

"There is a desperate need for more flexible products," said Patrick Bunton at the mortgage brokers London & Country Mortgages, "especially early repayment mortgages which have no redemption charge."

The Abbey deal is merely another way of spreading the discounts that lenders are currently prepared to offer. First-time buyers are still likely to go for the cheapest discount mortgages. But the bank believes that the prospect of skipping the mortgage payment each Christmas will prove attractive to many exisiting homeowners.

If demand is good Abbey plans to develop a more versatile version, possibly allowing borrowers to choose when they want to pay.

Midland has been looking at the Australian model, which allows a borrower to pay say $3,000 off in a good year, but withdraw say $2,000 in a bad year. Unfortunately, tax relief at source on mortgage interest payments (Miras) makes this unworkable in the UK, so modifications would be needed.

"We must actively market a product in which repayments can be easily varied,'' Mr Massey said.

Halifax Building Society, Britain's largest lender, introduced some flexibility when it allowed borrowers to apply different interest rates and terms to different parts of their loans. But it does not believe it can market a fully flexible product before 1996.

"This is the next step," a Halifax spokesman said. "We are looking at introducing the type of product where you can miss a repayment if you happen to be over-committed in a particular month. But we are not there yet."

With the Chancellor, Kenneth Clarke, ruling out further cuts in Miras this side of an election and with interest rates likely to peak earlier and lower than originally thought, fear of unemployment is seen as the one remaining obstacle to a housing market revival.

Introducing flexible repayments is only one line of attack. Lenders are also in talks with their insurers about beefing up the mortgage protection policies that they offer, most of which are of no use to those who need them most.

As they stand, mortgage protection policies are not a viable substitute for social security income support. The Government and the mortgage lenders agree that if the Government goes ahead with plans to weaken the state safety net for unemployed homeowners in October, a more comprehensive alternative will have to be found.

For example, Halifax sells its mortgage payments protector insurance policy, covering accident, sickness and unemployment, for pounds 6.90 per month for each pounds 100 of monthly mortgage payment.

However, it only pays out a maximum of 12 months' repayment and you must have been in continuous employment for 12 months previously for it to be valid. This is hardly suited to a labour force moving inexorably towards contract and part-time work.

A report from the Department of the Environment found that even among the 12 per cent of borrowers who had payment protection policies, there was no evidence that people had avoided mortgage arrears by drawing on their plans. Two-thirds of claims were unsuccessful, typically because of qualifying periods and the way in which the insurance companies interpreted the policies, the report said.

The quality of protection eventually available to the homeowner against the inability to keep up repayments depends on the outcome of the spat between the lenders and Peter Lilley, Secretary of State for Social Security. Essentially it is an argument about who pays. If it is the lenders then the homeowner will bear the brunt.