Banning Self Cert Mortgages would Spell Trouble for the Self-Employed

20-Oct-2009

Today, the Financial Services Authority (FSA) laid out its proposals for dramatic reforms in the mortgage industry.  The changes are focused on preventing consumers from borrowing more than they are able to pay back, and also on making financial advisers more 'personally accountable' to the FSA.  

One of the largest proposed transformations is a ban on self-certification mortgages, also known as self-cert mortgages.  This product currently allows consumers to borrow money for a house purchase without background checks being carried out on their income.  In the market at large there are obvious benefits from making all consumers prove their income.  However, are the self-employed and freelancers, the original target market of the self cert mortgage, going to suffer as a result?

Self cert mortgages are aimed at home buyers without a regular income, such as freelancers and contractors, people who own their own businesses and those with irregular salaries (such as salespeople reliant on commissions).    However, during the property boom, many people abused the fact that no proof of income was needed and inflated their incomes to buy more expensive properties. Such is the strength of feeling against self cert mortgages, that they are now being dubbed 'liar loans', due to the unscrupulous borrowing that took place.

In 2007, self cert mortgages accounted for a massive third of all new loans, amounting to approximately £100 billion that was paid out.  Due to the higher risk for the banks in lending to people who did not prove their income, interest rates on the loans were also typically higher than for conventional home mortgage loans.  The increasing gap between the houses that people bought and what they could actually afford inevitably led to disaster, and since the recent crash in the property market, many consumers have found themselves in serious financial difficulty.  

Under the proposed new regulations, consumers would have to provide verification of their income, in the form of pay slips dating back two years, and also possibly a copy of their P60 form.  Employers may also need to be contacted for confirmation.  However, this could cause problems for the millions of self-employed consumers in the UK who are in a position to purchase a property, but who would not be able to provide PAYE evidence of their income.  

If you are a freelancer, a contractor or you work in sales where a relatively low basic income can be boosted by commissions and bonuses for meeting targets, you would be in a rather uncertain position under the proposed new scheme.   Previously, if you wanted to purchase a property, you would have needed to provide an accountant's letter showing that you were trading and solvent, but beyond this you were not tied to the standard income proofs demanded by conventional mortgage lenders.

It is a shame that the people who would have genuinely benefited from self cert mortgages would stuffer the consequences of a ban the most, when the issues were largely caused by unscrupulous brokers that encouraged consumers into mortgages they could not afford, and consumers who were not entirely truthful about their earnings.  If the FSA do proceed with a ban on self cert mortgages, there will need to be some alternative, so that the many, many people in the UK with 'non-standard' incomes will still be able to take out mortgages.

In retrospect, the almost total lack of regulation left the self-certification mortgage system wide open to exploitation, especially at a time when people were making large returns from investing in expensive property. Therefore the solution would be to retain the features of this mortgage type, with a much higher degree of regulation so that self cert is less susceptible to the abuses of the past.