Crackdown on Risky and Irresponsible Mortgage Lending

By May 7, 2009Articles

Following the property crash and the Government bail out of several big banks, the Financial Services Authority (FSA) is considering placing limits on the size of mortgages offered to homebuyers, in a bid to halt risky mortgage lending.

Traditionally, lenders were prepared to lend 3.5 times a salary on single incomes and 2.5-2.75 times a salary for joint incomes, but with the propery boom this was increased significantly. Many high street lenders offered 5 -6 times a basic salary or mortgages in excess of a property’s value, and some, such as Northern Rock, Abbey and Halifax, sold mortgage products with a loan to value of 120% (the controversial Northern Rock ‘Together’ mortgage had a LTV of 125%).

Not surprisingly, many homeowners who took out such mortgages ended up falling into negative equity and getting their homes repossessed.

Amazingly, Northern Rock continued to sell 125% mortgages after it had received Government assistance: it lent £800 million on its ‘Together’ mortgages from September 2007 (when it received emergency funds from the Bank of England) right up until immediately before it came under public ownership – not surprisingly, the ‘Together’ mortgage accounts for 50% of Northern Rock’s arrears and 75% of repossessions.

Even in current market conditions, Northern Rock are still willing to lend 4.5 times a single income, and 4 times a joint income. In some cases, they even take into account bonuses and overtime when calculating how much people can borrow. It is alarming to think what would happen, in terms of their ability to repay, if these borrowers no longer received bonuses or overtime.

Many lenders consider such practices a risky gamble, and it seems so, considering the mess Northern Rock got themselves into not too long ago. Lending on a joint salary is also risky, as a woman may give up her job or go part-time in order to raise children.

In certain circumstances, Abbey will lend up to 5 times a salary, but is this too much, given the mess the UK is in at present? High street lenders swear they behave responsibly and now sell mortgage products in accordance with affordabiltiy criteria, but is this totally fail-safe?

Apparently, the FSA do not think so. Mortgage lenders have had a wide reign over the past 10 years, and the introduction of stricter lending regulations will help to prevent a reccurence of the property slump being experienced at the moment.

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The FSA are expected to bring in a series of reforms which will prohibit banks from indulging in risky lending practices and thus stabilise the housing market. Maximum lending will probably be limited to 3 (possibly 4) times a borrowers income – some organisations have expressed concern that this may mean some people will be unable to afford to buy a property, but the FSA’s sole aim is to prevent the market becoming dangerously overstretched again.

The FSA will publish a consulation paper in September 2009, putting forward various options for reform. These include a clampdown on the amount loaned, as outlined above, as the watchdog are concerned that people are overstretching themselves financially in order to buy a property. Thus, any definitive action from the FSA is not expectd until later this year.

Peter McGahan, an independent financial Advisor and MD of Worldwide Financial Planning (wwfp.net), comments:

“Unfortunately there is no exact science as to lending criteria. Is it fair to use the same criteria for someone on a variable rate mortgage versus someone who is on a 25 year fixed rate mortgage? Perhaps the better thought would be to allow banks to lend what they want but they have to do so responsibly. If they don’t and the customer falls into trouble they would be prohibited from repossessing. This would encourage lenders to treat customers fairly and self regulate.

Dropping lending criteria too steeply now would only  serve to take more people out of the market and drive demand and thus prices down further”.