Why mortgage borrowers could be left high and dry

The mortgage market is facing a huge overhaul. Check out the good, the bad and the mad proposals from the FSA.

This week the Financial Services Authority (FSA) set out its proposals for major reforms of the UK mortgage market. And in the process it showed a distinct lack of understanding of how the market actually works and what would help or hinder borrowers.

It wants to create a system that works better for consumers, but it has announced proposals that would be extremely unfair to many.

Luckily in some areas the regulator didn't go quite as far as some feared, plus it came up with some sensible suggestions too.

But the headline news -- the banning of self-certification mortgages -- is utterly daft and, in my view, does more harm than good.

Self-cert scandal

Self-certification mortgages - where the borrower declares their income and the lender guarantees not to check it - have had a chequered past. It's true the system was abused by some people who wanted to borrow more than they could realistically afford.

But, hang on a minute. A great many self-cert borrowers are self-employed, or have complicated income streams, and find it hard to prove all their income. There's nothing untoward about that. They just want to get a mortgage.

And for those who say that everyone should be able to prove their income - poppycock! I can't prove mine (my accounts are not audited and I've been freelance for less than the required three years anyway). Yet my partner and I could afford a mortgage twice the size of the one we have, plus we put down a substantial deposit. A lenders' dream apart from my employment status!

What about people who have already got a mortgage and then become self-employed or set up their own business? When their existing fixed rate comes to an end, for example, should they be denied the chance to refinance because they don't have the requisite accounts? Should they be forced onto their lender's SVR with no other options? Of course not.

How about existing self-cert borrowers? What are they supposed to do when their current deal is up? It's not exactly fair to tell a borrower that they must take their lender's standard variable rate which has the capacity to rise steeply because they are not allowed to switch to a fixed rate, even if it is a safer option for them.

What if their lender has left the market, as many have? A significant 10% outstanding mortgages are currently self-cert deals. These people might want to move house? Is it fair that they are not allowed?

Self-cert could be cleaned up without banning it. It could be allowed for the self-employed only (I know it's not easy but it's possible). Other criteria could be applied to minimise the risks. But the self-employed need a self-cert option.

For a very different view on this subject see Ed Bowsher's blog: Good riddance to liar loans.

Affordability tests

The FSA also suggests imposing affordability tests for all mortgages and making lenders ultimately responsible for assessing a consumer's ability to pay. In other words, lenders should calculate not only the money a borrower has coming in but also the money that is going out -- looking at the number of dependants a borrower has and other financial commitments like loans and credit cards.

This makes sense and lenders have been using affordability calculations for years anyway, but the difference is that the FSA now says they should have complete responsibility for checking this. Some argue that consumers ought to carry some of the responsibility here too -- after all we are the ones asking to borrow.

What the regulator hasn't done (thank goodness) is to set maximum loan-to-income limits (i.e. three times income tops) and loan-to-value ratios (meaning all borrowers would need a certain deposit in order to get a loan) -- something they did seriously consider.

This would have been as bonkers as banning self-cert and thankfully the FSA decided against effectively designing products itself. However it explicitly noted in its report that it "has not ruled out further change if the initial proposals do not have sufficient effect, including caps on loan-to-value, loan-to-income or debt-to-income." Gulp.

Regulation of buy-to-let

There has long been debate about whether to regulate the buy-to-let mortgage market, which was specifically excluded from wider mortgage regulation back in 2004. Now the FSA has decided it should come under regulation.

Regulation would give buy-to-let borrowers the same rights and protection as other borrowers, as well as access to complaints and redress schemes such as the Financial Ombudsman Service.

And since many landlords are regular people with one or two properties, AND not professional property magnates, they are classed as amateurs and need protection.

Regulation would also drive rogue firms out of the sector, such as dodgy property clubs that promoted off-plan speculation and led to many investors getting their fingers badly burnt.

However...

Others argue that buy-to-let mortgages are commercial products not residential and should therefore not fall under residential mortgage regulation. They say that buying-to-let is an investment, and that the choice of the property, the tenants and how it is managed (which cannot be regulated) have as much bearing on the success of the investment as getting the right finance.

It's also true that the majority of property in the private rented sector is actually owned by large scale landlords, not amateurs, who do not need or want consumer protection.

Plus many buy-to-let advisers are already members of bodies such as the National Association of Commercial Finance brokers which has its own code of conduct for advising and selling buy-to-let mortgages. Indeed most are also regulated for mainstream mortgages anyway.

Finally, mortgage regulation in 2004 didn't exactly make the market any safer, did it?

The end of toxic products

The FSA also proposes banning the sale of products which contain certain 'toxic combinations' of characteristics that put borrowers at risk -- for example a sub-prime mortgage at 90% combines the bad credit history risk with the high loan-to-value risk. Fair enough, but the market had figured this one out for itself.

Plus it plans to ban arrears charges where the borrower is already in a repayment plan. In other words, lenders shouldn't be profiting from borrowers in arrears. I think we can all agree with that.

It is important to note that, despite press reports, all of these proposals are simply proposals not rules. The regulator is actively seeking feedback before publishing a further statement next March.

Clearly the aim of the proposals is to make the market safer, but the cost seems too great for too many mortgage borrowers who have done nothing wrong and could be left high and dry by the very body that is supposed to look out for them.

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