Mortgage identity crisis – tarred with the sub-prime brush?

My name is Jonathan and I am a Northern Rock borrower…

I borrowed from Northern Rock to fund a property purchase at the end of the Summer but recent press coverage has caused me to have something of a mortgage identity crisis. As we know, the collapse of the US sub-prime mortgage market sparked a global credit crunch incompatible with Northern Rock’s business model. It is simply not possible to read an article about Northern Rock without also reading about sub-prime loans – so have I been tarred with the “sub-prime” brush?

Sub-prime typically covers loans to those with poor credit histories and is exemplified by the infamous NINJA loan (no income, no job or assets) from the US. In the UK, it is estimated that between 7 and 8% of mortgage lending relates to borrowers with damaged credit histories, and this market plays an important role in helping people back to the prime market. However, has sub-prime now taken on a wider meaning that could have a long term negative impact on consumer confidence?

Any mortgage product which has a higher level of risk for the lender or borrower appears to have been slapped with the sub-prime tag. I am referring to products which contain an element of financial complexity, customer vulnerability or lock-in. For example, self-certification mortgages, interest-only mortgages and equity release plans.

My particular Northern Rock product allowed me to borrow 95% of the purchase price and take out an unsecured loan of up to £30,000 at the same rate as the mortgage – 5.89% fixed for five years and interest only. I decided to maximise my borrowing to consolidate debt and cover the costs of the purchase. The long and short of it is that I borrowed 110% of my property’s purchase price and the monthly repayments account for 33% of net income, or around 23% of gross income.

On the face of it some may classify my Northern Rock loan as sub-prime lending for two reasons: First, should the balloon go up tomorrow Northern Rock will not get all of its lending back (the lender’s risk). Second, I am not repaying capital and am exposed to volatility in the market (the borrower’s risk). However, if we dig a little deeper sub-prime is not necessarily a one size fits all label.

My view is that the risks associated with buying property can be off-set by a combination of proper financial advice, scope for adding value to the property, being able to afford the repayments and having a longer term outlook (a house is a home not just an investment kind of sentiment). Lucky for me, I have already made some improvements to my property, have insurance in place to cover ill-health/unemployment and intend to switch to a repayment mortgage in a couple of years.

I anticipate that these are the kind of issues being brought into sharp focus for higher risk borrowers and their mortgage brokers. What if you (or your client) are bordering on negative equity? Cannot afford the repayments following interest rate rises? Have a self-certification mortgage and are struggling for income a few years down the line?

In addition, on 26 November the FSA announced that it will be clamping down on non-compliant and negligent mortgage brokers. This followed seven firms being fined or shut down this year, the referral of a further seven firms for investigation and 65 other brokers being asked to check their processes. Looking back further it is easy to say with hindsight that the writing was on the wall. In January this year the FSA issued a press release announcing disappointing mortgage advice in 252 firms through mystery shopping, questionnaires and firm visits in 2006.

The FSA is certainly targeting higher risk lending before beginning a further review of the quality of mortgage advice and processes in January 2008, concluding in June 2008. Key issues for brokers are going to be affordability, checking implausible financial information, key features and offer documents, training and competency standards, senior management monitoring and control, the likelihood of money laundering and treating customers fairly.

Published 30/11/2007. The author of this article is Jonathan Kitchin