Self Certification mortgages are appropriate for some borrowers

Posted on 7 July 2009 by Ray Boulger

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This morning the Treasury Select Committee took evidence on "Mortgage arrears and access to mortgage finance" from, among others, Jon Pain, FSA Managing Director of Retail Markets. He told the committee the market for specialist mortgages had "reduced to almost non-existence" and when asked if he thought lenders should be encouraged to begin offering these loans again, even though arrears levels are higher than on mainstream mortgages, he said: "90% of these mortgage customers …. are still sustaining their mortgage accounts so we have to think very carefully about just eliminating this part of the mortgage market, otherwise you will close off opportunity for consumers."

The specialist market is categorised as self certification, but-to-let (BTL) and sub prime and of these the highest arrears levels will undoubtedly be in the sub prime sector. Fraud has been a particular problem in the buy to let market, particularly in relation to overvaluations of new build properties and so, based on Jon Pain’s figures, and especially after excluding fraud cases, arrears levels in the self cert and BTL market appear to be only modestly higher than in the mainstream market. A higher level of arrears in these markets is budgeted for by lenders, which is why the rates, and sometimes fees, charged are higher.

It is very encouraging to hear Jon Pain’s comments, as it makes clear the FSA recognises that providing they are properly underwritten and priced there is nothing wrong with specialist mortgages and that there would be considerable consumer detriment should these types of mortgage disappear from the market. Although US sub prime mortgages were the catalyst for the credit crunch it is important to recognise that US and UK sub prime mortgages are a world apart and in dealing with the problems caused by the credit crunch we must not throw the baby out with the bathwater.

The principal responsibility for the market failures since 2007 must lie with the Boards of the companies which were bailed out by the Government in order to protect the public and maintain confidence in the banking system. However, the regulators, and the Government which set up the current regulatory system, must also bear a large part of the blame as clearly the regulators also failed in their role. But the key point is that it was the sudden withdrawal of the availability of wholesale funding that caused the crises, not bad lending.

It is not unusual to see regulators and politicians who have failed to prevent a problem overreact after the event by imposing measures which are too draconian. But it is crucial to get the balance right in the regulatory response and Jon Pain’s comments are encouraging in this respect. Just as it is important after an airliner crash to find the black boxes in order to have as much information as possible about the cause of the crash to identify the what action is needed to reduce the possibility of another crash, it is important to fully understand not only how each mortgage product has performed in the current market but also whether any underperformance was more than expected and if so why.

A regulatory overreaction will cause different problems in the future and unfairly and unnecessarily discriminate against some borrowers. There have been suggestions, including from some politicians with little understanding of the mortgage market, that self certification mortgages should be banned. The rationale for this seems to be fairly simple – everyone should have to prove their income before being granted a mortgage.

This overlooks the reality of life for a significant minority of borrowers, primarily the self employed. Even without any overt regulatory action we are already seeing many self employed clients with good accountants, part of whose job is to legally keep their clients’ tax liabilities as low as possible, seriously disadvantaged at best, or excluded from the mortgage market at worst. It is well known that self employed people can legitimately set off against their profits some costs which employed people would have to bear out of their taxed income.

Some self employed people will still declare profits large enough to enable them to qualify for a mortgage of the size they want, but many can afford a bigger mortgage than their taxable profits suggest. Some clients are blissfully unaware of the impact this now has on their ability to get a mortgage until they want one, either to purchase a property or to remortgage. Thus there is a direct conflict between what the accountant should do to minimise their client’s tax liability and to maximise the same client’s mortgage capacity.

Prior to the credit crunch this was not a problem for most self employed people because self certification mortgages were freely available up to 90% loan to value (LTV), although the cost was higher than for mainstream prime mortgages, particularly at the higher LTVs to reflect the extra risk. However, only two lenders are currently offering self cert mortgages – The Mortgage Works (a Nationwide subsidiary) and Platform (a Britannia subsidiary) and the maximum LTV generally available is 70%. Furthermore the only deals available are fixed rates for 2 or 3 years and the rates and fees are very high.

The FSA’s mortgage consultation paper due in September will be looking ahead to whenever there is more capacity in the mortgage market. Despite our many anti discrimination laws I don’t believe there is one making it illegal to discriminate against self employed people – maybe there should be! A ban on self cert mortgages would be discrimination and would be very damaging for the majority of self employed people. Even existing borrowers with a perfect payment record would have a major problem if self cert mortgages were banned. Those wanting to move would find in most cases they couldn’t get a new mortgage, and those wanting to remortgage would not be able to and so would be at the mercy of their existing lender.

Today’s evidence from Jon Pain suggests a ban on self cert mortgages is not on the FSA’s agenda and welcome though this will be for many self employed people the fact remains that most lenders have currently effectively banned them, at least for the time being. Unfortunately lenders have to worry not only about what the FSA thinks but also what the discredited rating agencies think. I find it amazing, and unacceptable, how much power the rating agencies still hold, bearing in mind their complete failure to spot the problems, until they were obvious to everyone, in the residential mortgage backed securities supported by US sub prime mortgages. Until this power is severely reduced lenders unfortunately can’t afford to ignore them and generally the rating agencies have a very blinkered view of self cert and BTL mortgages, possibly on the basis of overreacting after their previous failures to spot problems.

Before granting a self cert mortgage a lender does all the normal credit checks except for requiring income to be proved. Whether the mortgage is approved depends on the credit score, which is used by most lenders to decide on most mortgage applications. Lenders claim that the credit score is the best predictor of borrowers’ ability and willingness to pay and indeed the Basle 2 rules effectively strongly encourage credit scoring. Credit scoring is far from perfect but if credit scoring is accepted as the best method of assessing a mortgage application there is no reason why is can’t be used to assess self cert applications. Alternatively lenders should not rely on it so much for mainstream applications.

Providing a self cert application passes a sense check by the broker and lender and the borrower has a clean credit record there is nothing wrong with self certification mortgages. The lender must of course decide what maximum LTV is appropriate and what the appropriate premium is over the pricing of a mainstream mortgage to reflect the additional risk. This detail should be left to the market, without limits specified by the FSA or effectively by a rating agency. If the FSA feels it may need some powers to influence this market when conditions improve it could specify how much extra capital lenders must have to support self cert mortgages, although even this may not be necessary as the Basle 2 rules already require extra capital to support more risky mortgages.  

Categories: Buy to let, Mortgages, Regulation

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