Bid to end risky mortgage lending

FSA proposes three-point plan to avoid threat of another unsustainable lending boom.

The Financial Services Authority (FSA) has unveiled plans to shake up the mortgage market and end the risky lending seen in the pre-credit crunch years.

The final consultation draft of the financial regulator’s Mortgage Market Review aims to instil “common sense standards” across the industry.

The FSA wants lenders to thoroughly check “each applicant’s realistic ability to repay their mortgage” and end lending that is hedged on future house price rises.

In 2007, over 50% of mortgages were arranged without the lender verifying the borrower’s income.

The three core principles of the FSA's proposals are:

• 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.  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.
• 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.

The FSA estimates that nearly half of borrowers who have taken out a mortgage since 2005 are what it terms ‘mortgage prisoners’. These people are trapped by a lack of the high loan-to-value mortgages they need or by negative equity or by past payment problems.

The FSA says that lenders will have the opportunity to offer new mortgages to people with good repayment histories “even where they do not meet the new affordability requirements”. This would potentially prevent them from running into difficulty if they moved to a lender’s Standard Variable Rate at a time when interest rates were rising.

Too little, too late on interest-only mortgages?

If the proposals are implemented, the third principle could lead to a reduction in the availability and sale of interest-only mortgages. By 2007, these accounted for a third of all mortgages. Yet it’s estimated that 78% of these mortgages have no repayment strategy. And less than half of this type of mortgage is classified as low risk.

At present, these mortgages are often offered to people who have run into difficulty with a repayment mortgage.

However, in terms of tightening the lending criteria for interest-only mortgages, it may be a case of too little, too late. The FSA estimates that 1.5 million of these mortgages are due to be repaid in the next 10 years. But it found that at least 37% of recent mortgages due for repayment had to have their terms extended because borrowers were unable to repay them.

The FSA says it believes the impact of its proposals on the current mortgage market would be minimal, but would have a “highly desirable” effect in the event of another lending boom.

It has put the proposals out for consultation until the end of March. The final rules are not likely to be implemented until 2013.

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