Good riddance to liar loans

by Ed Bowsher on 19 October 2009  |  22 comments
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This clampdown by the regulator means you can no longer lie about your income and get a mortgage. But the FSA hasn't got everything right.

I've spent the morning reading the FSA's Mortgage Market Review. It's an interesting document with several sensible proposals. Top of the list is a ban on self-certification mortgages.  

Self-cert mortgages are where the lender doesn't ask for any proof of income. Way back when, self-employed people would have to provide proof of earnings for several years before they could get a mortgage. So the move to self-cert was welcomed by many people. 

The problem was that lenders started doing self-cert mortgages for people who were actually employed but were poor credit risks. So it's no surprise that the FSA's research shows that self-cert mortgages were much more likely to default than conventional mainstream mortgages. 

The FSA hasn't specified how much proof should be required. I'm not saying that someone should have to provide five years' history of earnings. But it's quite reasonable that a borrower should provide some evidence of earnings before being granted a loan. 

Doing this will have several advantages: 

• By reducing default rates, it will protect the strength of our banks which is good news for the economy and bankers.
• It means that the rates charged on mortgages for self-employed people would be lower than they would otherwise be.
• Imprudent borrowers would be protected from their own folly. You might think that in a free market people should be allowed to make their own mistakes. There's something in that, but I suspect that some borrowers didn't understand the risks they were taking. And if market participants don't fully understand the market - they don't have 'perfect information' in the economists' jargon - you don't have a true free market. 

Affordability 

The FSA's report also looks at whether Loan-to-value (LTV) and loan-to-income (LTI) ratios should be capped. If you have a 5% deposit, the LTV ratio is 95%. If the total debt is five times your income, your LTI ratio is five. 

Many commentators - including Gordon Brown - have said that 100% mortgages should be banned, whilst others have criticised mortgages with an LTI ratio of five or more. 

The FSA isn't proposing any such bans because it fears unintended consequences. It also argues that mortgages with high LTVs or high LTIs don't have high default rates on their own. Default rates only rise dramatically when other factors are included such as self-cert or people with poor credit histories. 

Instead the FSA wants lenders to focus much more closely on the borrower's levels of spending and see whether the borrower can truly afford the loan repayments. 

The biggest problem

Looking at affordability is sensible but I'm still inclined towards some kind of restrictions on LTI and LTV.

I think the biggest problem we've had in the property market has been the stunning rise in house prices over the last ten years. In the decade before the financial crisis, UK property prices rose by almost 300% yet the growth in average earnings was only 50%, according to the FSA.

That growth in prices had many causes, but it was also a big factor in triggering the problems that we now face. It created an atmosphere where property was seen as a one-way bet which then led to irreponsible borrowing and lending.

Hopefully, over the next ten years, prices will rise much more slowly and more in line with economic growth. I think limits on LTVs and LTIs could help on that, so I think the FSA should think again. 

> Check out more of my musings at my blog

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