Housing market 'faces abyss' over new rules on mortgages

The Financial Services Authority wants early next year to restrict advances sharply, scrap self-certified mortgages, impede interest-only loans and block fast-tracked arrangements.

If it presses ahead with its plans, nearly 20 per cent of existing borrowers may be unable to remortgage without reducing their debt significantly, funds available to borrowers overall could be reduced a further 10 per cent, and the self-employed may be prevented from taking that first step on the property ladder.

Rather than safeguarding borrowers, these proposals could lead to rocketing repossessions, experts warn.

Peter Williams, chairman of the Intermediary Mortgage Lenders Association, said: "This really is a step into the abyss. By 2012 the UK mortgage market could be unrecognisable. It will be a conservative market serving only the relatively well-off."

Rod MacLeod, of solicitors Tods Murray, added: "The proposed regulations are likely to wipe out a sizeable chunk of lending in the short term which could have longer-term consequences for an already fragile UK property market."

The FSA's consultation paper accepts that 17 per cent of recent borrowers would have had to reduce the amount they applied for to pass the new affordability tests. Total lending would be 9.6 per cent lower.

But these proposals have been greeted with horror by the lending industry. While none denies the housing market was riddled with abuse during the last property bubble, as rogue brokers encouraged borrowers to lie about their earnings and some banks dreamed up ever more fanciful propositions, they say regulators should be pursuing fraudsters, not punishing ordinary decent homebuyers.

They point out that plenty of regulation did exist throughout the last property bubble, but it was not enforced as watchdogs turned a blind eye to the excesses, which were obvious at the time.

Finally, they claim that even where borrowers did fabricate earnings to qualify for a so-called liar loan, no harm was done, because most subsequently coped with repayments.

Repossessions fell in the first quarter of the year to 9,800 and are expected to end the year below 50,000. This is a fraction of the last recession where 75,000 families were kicked out onto the streets annually, at a time where there were 9.8 million borrowers compared with today's 11.4 million.

Mortgage broker Ray Boulger, of John Charcol, said: "There is nothing intrinsically wrong with these loans which the FSA now wants to ban or severely restrict. If there was, why are the arrears figures so low given the worst recession since the 1920s?

"Problems arose because they were abused by rogue elements, and regulators did nothing to stop them."

Nevertheless, the Council of Mortgage Lenders is worried about repossessions surging again next year. Spokeswoman Sue Anderson said: "This looks like it will be a benign year for mortgage problems, but we are aware of difficulties coming down the track after tax increases, possible interest rate rises and the squeeze of the public sector."

Scotland on Sunday examines the proposals, how new and existing homebuyers could be hit, and suggests ways to get round them.

New affordability tests

The FSA wants to introduce tough new tests measuring your income and other outgoings which could cut the size of loan which some borrowers qualify for.

If you exaggerated your income on your last application, it has fallen, or you have been forced to take on new financial commitments or debts, you may find it impossible to remortgage or move house.

Top tip: Reduce debts and make sure you include all income, such as interest from savings accounts, in any applications. Use savings to cut the mortgage.

Interest-only loan

Some borrowers opt to keep payments low initially by paying interest only. This works when they know they have other investments which can settle the debt at the end of the term, or income will be higher to enable bigger repayments at a later stage.

At the peak of the bubble nearly one in three mortgages was sold on an interest-only basis. But the watchdog is worried that some borrowers do not understand the need for bigger repayments later and will have nothing with which to settle the loan at the end of the term.

For this reason it wants affordability calculated on a repayment model basis which allows for the debt to be repaid from day one. However, this can involve significantly higher initial monthly repayments.

Combined with tougher affordability checks, some borrowers who currently have interest-only loans will fail these new tests, making it impossible for them to remortgage or move house, and potentially leave them trapped on extortionate rates, unable to protect themselves against soaring costs.

Top tip: If you can't afford to switch to a repayment deal, consider an offset loan where positive balances can reduce the loan and interest payable.

Self-certified mortgage

These loans were introduced in the early 1990s to help the self-employed enjoy the same access to a mortgage as the employed. Before that lenders were very cautious about advances to anyone who worked for themselves, requiring three years of audited accounts. This penalised freelances, consultants, small businessmen, sole traders and even some professionals.

With self-cert loans, borrowers literally certified their own level of income but were charged a higher interest rate to cover the additional risk. As the army working for themselves grew, the numbers taking out these loans mushroomed.

Initially, the default risk was low, so the additional risk premium was reduced, making them an attractive alternative for many other types of borrowers apart from the self-employed. During the bubble, self-cert loans were used by all sorts of people to get loans which in many cases their income would not have justified.

Now the FSA wants to ban them completely, while at the same time acknowledging this will at the very least delay some self-employed entering the housing market. At worst, they may struggle to ever get the kind of house they aspire to, which may make staff reluctant to give up paid employment to set up a business on which the economy relies for new jobs.

Boulger said: "This will be very hard on the self-employed, who may have to wait for a few years to produce proper accounts, and whose real income may never be properly reflected by their accounts because of the legitimate writing down of expenses. What we need is a common sense check. Lenders should look at the income being claimed and ask whether this is plausible.

"I remember we had one case where someone claimed to be a taxi driver with an income of 80,000. This didn't ring true so we made further inquiries and he turned out to be a personal chauffeur and bodyguard of a high-profile personality."

If the FSA's proposals proceed it may be impossible for the self-employed to get the mortgage they require or for existing borrowers to remortgage.

Top tip: Write to your MP.

Fast-track

This allows borrowers to experience a speedy service because lenders do not actually write to your employer to confirm the information you have given them about your job and salary.

When borrowing direct from a bank or building society, they will conduct credit checks with reference agencies and may also ask to see bank statements to verify your income and outgoings.

Where you are arranging a mortgage through a broker, a lender will ask the broker to make sure they have evidence of your income and bank statements etc, but may not require to actually see it themselves.

These strategies not only speed up the process for the borrower, but help lenders cut costs: a benefit which can help keep mortgage rates squeezed.

At the height of the bubble a huge proportion of loans were fast-tracked, including advances of as high as 95 per cent of the value of the property. That has now fallen to 75 per cent typically.

However, the FSA wants fast-track to be abolished, and for all income-related information to be fully verified with employers and so forth. This will put up costs and slow the process for all borrowers, as well as banks and building societies which will have to increase their processing departments, meaning admin backlogs may become common.

Top tip: Keep your credit history as clean as possible and reduce your loan to 75 per cent of the value of a property.

Vulnerable borrowers

Borrowers with a poor credit history are at particular risk of being hoodwinked into taking out loans they cannot afford. For this reason, the FSA wants them to be subject to even stricter affordability tests with a 20 per cent additional buffer built into their calculations.

This means they will be eligible for 20 per cent smaller loans than other borrowers. While sensible, this could cause real hardship for existing homeowners with a poor credit history, who will not now be able to remortgage onto cheaper deals, leading to a significant upturn in repossessions.

Top tip: Where previous credit default is a minor matter, some lenders may treat you as a mainstream borrower. Speak to a broker who can point you in the right direction.

Case Study: 'We needed home loan in a hurry'

PAUL and Nicola McFadyan moved into their new house in Paisley on Thursday, and will today be enjoying the first weekend in what they hope will be their "future-proof" home.

They found the entire mortgage and moving process astonishingly simple, but Paul says he is concerned that proposed credit constraints could cause problems for some borrowers if they come in as now suggested.

Paul said: "We got married about a year ago, and we have been living in a three-bedroomed terrace in Glasgow. But we wanted a house which was big enough to accommodate a family, if it comes along later."

To his astonishment, they sold their Glasgow property in a single day via estate agents Raymond Logan Property Services. So he and Nicola, who is a teacher, needed a mortgage quickly. However, as a financial adviser himself, he was concerned that his income structure would cause problems.

He explains: "I went to the Yorkshire Building Society because I know they offer good deals, but I was concerned because although I am salaried, I have a basic salary and then a bonus structure. This means I have two payslips and my bonus can fluctuate. However, Yorkshire contacted my employer, who confirmed my income, so there were no problems."

Paul said in some ways the experience reassured him that simply because a lender requires additional income verification it does not always cause problems. However, he added: "I am aware of clients I deal with who could experience problems."