The Financial Services Authority has today announced new plans to ensure that risky mortgage lending does not re-occur in any future boom.
The aim of the Mortgage Market Review (MMR) is to prevent a replay of the irresponsible mortgage lending that happened in the last property price boom when the assumption was that house prices would always go up.
This led to the belief that mortgage lending had become risk free as the lender could quickly repossess and re-sell on the property of any distressed owner. So mortgages were given out with abandon and precious few of the traditional affordability checks.
Now that the bust has firmly set in it comes as little surprise that many home-owners are now suffering. As a result the mortgage market has been forced into more sensible lending policies by the pressures of rising mortgage arrears. It is worthy of note that some 605,000 people that borrowed prior to the credit problems would not now qualify for a loan on those same terms.
But there are other considerations.
Nearly half of those that took out a mortgage since 2005 have ended up as ‘mortgage prisoners’ in that they do not meet the criteria for a new loan so are trapped into the one they have.
For those that bought with a mortgage between 2005-10 15% may be in negative equity (owe more than the house is worth), which could be 30% of first time borrowers.
Worse still just a modest rise in interest rates, which are historically low, would force many into arrears.
But the FSA is now looking to the future with the MMR. It is determined to have the new regime in place well before any future boom and it has established three principles for ‘good mortgage underwriting’:
Mortgages and loans should only be advanced where there is a reasonable expectation that the customer can repay without relying on uncertain future house price rises.Â Lenders should assess affordability;
This affordability assessment should allow for the possibility that interest rates might rise in future: borrowers should not enter contracts which are only affordable on the assumption that low initial interest rates will last forever; and
Interest-only mortgages should be assessed on a repayment basis unless there is a believable strategy for repaying out of capital resources that does not rely on the assumption that house prices will rise.
Income will now have to be verified in every case. No more ‘fast-tracking’ or ‘self certification’ mortgages.
Although lenders will not have to inspect the minutiae of a borrower’s financial position they must not ignore the obvious, such as council tax and gas/electricity.
The interest only mortgage has survived but any capital amount repayment plan must be credible. And the loan will be assessed on a repayment basis anyway.
The lenders will also have to take into account the likely route interest rates will take in accordance with market expectations.
Borrowers looking to consolidate loans will have to be given full advice on the future implications of doing so.
However, those with current loans will be dealt with more flexibly so that they can get new loans even though they would not qualify under the new regime.
Older borrowers may well be hit hard by the new rules as lenders will be expected to scrutinise the borrower’s financial position the closer they are to retirement. This could presumably also affect first time buyers should they be reliant on an older relative to be a guarantor.
The Chairman of the FSA, Lord Turner, said:
We believe that these are common sense proposals which serve the interests of both lenders and borrowers. While the excesses of the pre-crisis period have largely disappeared from the current market, it is important to ensure that better practice endures in future when memories of the crisis recede and the dangers of poor practice return.
Speaking on Sky News Paul Smee of the Council of Mortgage Lenders said that this was effectively the FSA catching up with current lending practices. He said that there would now be more scrutiny of borrowers' positions and a requirement for more evidence so as to prevent a future re-run of the credit crunch. People would more likely need to save for longer and get on the housing ladder later he said.