Some lessons have clearly not been learnt from the credit crunch.
The collapse of Northern Rock changed the landscape of mortgage lending in the UK back in 2007. It soon became clear that lending at high loan-to-values, sometimes in excess of 100% of the property’s value was simply not sustainable.
What’s more, lenders became more stringent in their affordability tests when receiving applications, putting the applicant’s claims through rigorous modelling to ensure that they were not lending to borrowers who could not afford it. In addition, the FSA set out even tougher tests that it wanted to see the lenders implement.
The days of slack lending were at an end.
At least that’s what they told us. But it seems that things may not have changed so much after all.
According to the FSA’s chairman, Lord Turner, borrowers are ramping up their debt to a level not seen since the financial crisis first hit. Turner explained that 28% of new mortgages in 2010 were for amounts greater than 3.5 times the borrowers’ income – the last time the figure was so high was in 2007.
Of course, the actual number of borrowers putting themselves at risk is pretty small, as mortgage borrowing during 2010 was at a very low level. In total there were just 842,500 mortgages for both purchase and remortgage across the year, down from 919,500 in 2009 and 1.38m in 2008.
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But by stretching themselves, many of these borrowers are putting themselves at more risk than was the case previously, due to the popularity of variable rate mortgages. According to Legal & General, as many as 90% of active mortgages in the market today are on variable rates.
That’s an awful lot of borrowers who will be hit in the pocket when base rate starts to move up in the coming months. For more have a read of Rate rises will hit 90% of borrowers.
Tough new borrowing rules?
Of course, lenders will not be able to get away with lending at such high income multiples for too long, as the FSA’s new affordability rules will be coming in soon. As I explained in Secret new rules set to reduce house prices, the regulator’s Mortgage Market Review will oblige lenders to use far stricter affordability tests before approving a mortgage.
However, the FSA has now admitted its proposed rules were too strict and has started backtracking.
It admitted that its ‘one size fits all’ approach – which involved assessing whether borrowers could afford the mortgage based on a 25-year repayment loan, even if they were applying over a longer term or on an interest-only basis – was no longer appropriate.
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Personally, I’m glad that the FSA has seen sense and listened to the feedback that warned the regulator its rules were over the top. However, coming in the same week that they admitted a large chunk of last year’s borrowing is a major concern, it just seems a bit hypocritical.
Besides, focusing on income multiples when assessing the suitability of a mortgage is a bit too simplistic in my view. Whether I’m borrowing twice my annual salary (fat lot that would buy!) or five times my salary, the priority for any lender should be whether I can afford the repayments themselves.
And that means assessing all of my finances. A borrower may have a salary of £50,000 a year and want to borrow £120,000, which seems reasonable enough, but if he finishes every month in his overdraft and is up to his eyeballs in credit card debt, then he may not be such a great prospect.
Alternatively he may only earn £30,000 a year and want to borrow £120,000, but be particularly frugal with his finances – no debt, no credit cards, a healthy chunk of his earnings going aside in savings every month. He may be borrowing four times his salary, but there’s a decent chance he’ll be able to make his mortgage payments every month.
What’s more, the FSA is at last showing some mettle and taking action against lenders who have employed ropey lending practices in the past.
Back before the crunch hit, DB Mortgages (owned by Deutsche Bank) was a player in the specialist mortgage market – in other words, sub-prime, self-cert, basically any lending that would not fall within the bracket of ‘mainstream’.
And sadly, some of the lending that DB Mortgages indulged in was somewhat questionable.
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According to the FSA, the lender failed to demonstrate to borrowers whether they could afford the mortgage if the term continued after they had retired, failed to consider they may be cheaper mortgages available for those seeking a self-cert mortgage, and failed to ensure that customers had considered what they would do – and where they would live – if they needed to sell their house to pay off an interest-only mortgage.
And when borrowers fell into arrears, the lender’s treatment of them was not up to scratch, failing to consider individual circumstances and levying unfair fees.
As a result, DB Mortgages has been fined £840,000 and ordered to pay £1.5m towards those affected customers. According to the FSA, this is the first time it has had to take action against a lender because of its lending practices, and the regulator has admitted it is investigating a second lender at the moment.
There should be no doubt that some seriously questionable lending took place during the boom years, so it’s good that the FSA is cracking down. It’s just a shame it’s taken this long.
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