As if it has not been difficult enough to obtain a mortgage over the past few years, things may be set to get even trickier for new homebuyers. The Financial Services Authority (FSA), the company that currently regulates the UK's financial services industry, has published a report outlining proposals for further tightening mortgage lending criteria.
Of course, for most of us a mortgage is the single largest financial commitment we will take on, and it stands to reason that mortgage holders should be able to comfortably meet the repayments. However, the report has met with a mixed response from the industry. Although debt charities welcome the suggestion of offering consumers increased protection, some in the mortgage market are concerned that stricter regulation will make mortgages even more expensive for homebuyers, as well as less accessible.
What does the report say?
The main aim of the FSA's report is to put forward suggestions for responsible practices in time for the next economic 'boom' period, based on the learnings from past mistakes. The three main areas covered by the report are:
An interest-only mortgage is one where you do not need to repay any of the actual amount borrowed until the end of the mortgage term. As the name would suggest, you would only need to repay the interest on the mortgage each month. The idea is that if you took out an interest-only mortgage, you would also have an investment portfolio in place (an endowment policy is a common complementary product) that would grow over time giving you the necessary funds to clear your mortgage at the end of the period.
According to the FSA, many homeowners count on future house price rises to provide them with the capital to repay their mortgage. Of course, this plan only works as long as house prices continue to rise. Several years ago, this gamble failed spectacularly for thousands of UK homeowners when the housing market collapsed and many people found themselves with properties worth less than the value of their outstanding mortgages (known as 'negative equity'). Recognising that interest-only mortgages are becoming increasingly popular, the FSA wants much stricter regulations on who can get accepted to avoid people getting into financial difficulties.
Self-certified and Fast-track mortgages
Self-certified (or 'self-cert') mortgages are products available to self-employed consumers, or to anyone who for different reasons has a non-standard income stream. During the last mortgage 'boom' period, the regulations on self cert mortgages were relatively lax and unscrupulous lenders started offering self-cert mortgages to anyone who was not able to get accepted elsewhere. Needless to say, some people got accepted for mortgages when they could not really afford them. Now that lending criteria are so restricted, it's much more difficult to get a mortgage without verifying your income, but the FSA would further clamp down on acceptance for this type of mortgage.
However, there is still a 'fast-track' mortgage application process. This is available only to homebuyers with an excellent credit rating and a larger house deposit. Due to the lower risk that they present to the lender, the income verification for these individuals is not quite as rigorous. In their report, the FSA is suggesting a higher level of regulation for fast-track mortgages. They accept that fast-track mortgages actually result in a lower than average level of missed mortgage payments overall, but expresses concern that the fast-track mortgage will become the new self-cert mortgage, with the more relaxed income checks being exploited by lenders looking to get new mortgage customers accepted.
How much borrowers can actually afford
The FSA have made recommendations that lenders establish a 'maximum borrowing capacity' for every consumer looking for a mortgage, based on their income, their expenditure and their disposable income. Shockingly, they found that 46% of households either had no money left, or had a shortfall after mortgage payments and essential living costs were deducted from their income each month.
The report also recommends that lenders take future interest rate rises into consideration, especially if potential borrowers are not particularly financially stable already. Customers with a lower credit rating should also apparently be on the 'high-risk' list, something which sounds reasonable considering that these would be people who have missed three or more months' worth of loan repayments, had a county court judgment (CCJ) taken out against them due to debt, or have recently been declared bankrupt.
Are borrowers experiencing 'the calm before the storm'?
The FSA suggests that the current low interest rates may be masking future problems for mortgage holders - their data indicates that people who took out a mortgage in 2007 and then remortgaged or moved to their lender's standard variable rate mortgage in 2009 or 2010 saved an average of 140 GBP on their monthly repayments. The danger is that even a modest future rise in interest rates could seriously increase the number of households struggling financially.
The report makes the point that 'when borrowers are financially stretched, they have less capacity to save, making them particularly vulnerable to unfavourable life events or income shocks in the future'. The danger is that people may take on further debt in order to meet their mortgage payments, so that affordability issues may not come to the fore until several years after the start of the mortgage term. For example, someone with a 600 GBP income shortfall a month could cover this shortfall for three years by taking out a further loan of 25,000 GBP. By the time this debt starts catching up with the borrower, they could be at serious risk of losing their home.
Are mortgages going to become more expensive?
The main concern in the mortgage industry is that if both self-cert and fast track mortgages are consigned to the history books, it will become even harder for consumers to get accepted for a mortgage. Also if mortgages for 'lower risk' consumers require stricter income checks, the danger is that the administration fees for these mortgages will go up. Mortgage organisations such as the Council of Mortgage Lenders (CML) also argue that the industry has now learned from the mistakes of the past and that increasing the regulation for mortgages is unnecessary.
Some positive feedback comes from Malcolm Hurlston, chairman of debt charity Consumer Credit Counselling Service, who comments: "Buying a home, particularly for the first time, is a huge step. It is the biggest financial decision that most people will have to make so it is important that they make the right choices. Banning self-certified mortgages, and adding increased protection for those with a history of debt problems, will help inform these decisions and prevent people from being sold a home they cannot afford."
The FSA report forms part of a wider review of the lending practices of the past, and the consultation and research will be ongoing until November. To request a callback from an experienced mortgage adviser, simply fill out our short form.