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How sub-prime lending is changing
5 April, 2006
Ian Giles explains the growth of the specialist lending sector and argues that ‘sub-prime’ is no longer the correct term to use for the new non-standard borrower
Not so long ago the only choices available to the borrower who didn’t fit mainstream lenders’ standard criteria were ‘take it or leave it’. Now the specialist mortgage sector has developed into such a rich and sophisticated marketplace that customers can find a product to suit virtually every lending situation.
The modern specialist sector is a result of forward-thinking lenders realising that they had to become more customer-focussed and create products that met the needs of their borrowers. A greater level of customer understanding is not only vital in developing the right mortgages; it is also important for mortgage brokers to ensure they recommend the most suitable products for their clients.
Today the specialist sector accounts for £60 billion worth of lending in the UK – just over 20 per cent of total mortgage lending – and it is growing. A report published last year by Datamonitor, the business intelligence analyst, estimated that more than nine million people struggle to get a mortgage from a mainstream lender, which is around a quarter of the UK’s adult population.
Changing circumstances
The reason the specialist sector is growing so quickly is that more people are finding themselves in situations that are deemed ‘non-standard’ by prime lenders. In the past, this would have usually meant credit issues, but now ordinary people like you and me are going through the kind of changes that happen every day, yet can have an impact on prime lending criteria.
Circumstances such as a change of employment or marital status can mean that a borrower could find it hard to get a prime mortgage. At Kensington, we have compiled a composite of the average specialist customer. They are male, early 40s, divorced, self-employed, earning either in the region of £35k or £40k and looking for £130k mortgage.
So even mortgage brokers that have never previously thought of themselves as non-standard intermediaries are now realising that they need the knowledge and access to a full scope of specialist solutions if they are to be able to help their clients.
When considering what products are best suited to their specialist clients, brokers should take into account four key factors; employment status, personal circumstances, income and affordability, and finally credit history. All of these factors should be considered in every customer situation but, with specialist lending, it is important to get a detailed understanding of how they impact on the borrower’s situation, as this the only true way of assessing their credit risk.
For example, a prime lender may turn down a newly self-employed person because they don’t have the necessary three years’ accounts. However, that person may well be embarking on a career as a consultant and could have a guaranteed contract in the bag. Intermediaries need to know there are specialist providers out there that will not just reject the client out-of-hand, but will instead look closely at the situation and make a common sense lending decision.
Understanding and flexibility
There are currently around three and a half million self-employed people in the UK, with around 300,000 new entrepreneurs joining their ranks each year. They also make up a large chunk of the customer base of UK brokers, according to Datamonitor. Research by the firm found that two-thirds of intermediaries have at least 25 per cent of their customer base made up by self-employed clients, with a quarter of advisers saying that at least half of all their clients are self-employed.
What a self-employed person wants, particularly in the very early years of trading, is understanding from their lender and some flexibility in their mortgage. For instance, many seasonal businesses have periods where income is strong followed by times when earnings are not so high. An ideal product for them would be a mortgage that enables them to make overpayments during the good times, and then draw on that pot of money to make underpayments when income is not so strong. Alongside the growth in self-employed people, there has also been a major change in UK working practices, with many people now employed on short-term and temporary contracts, or working as freelancers and interim managers. These jobs options could range wildly in terms of income and security, but invariably their status puts them outside of prime mortgages.
The same could be true of so-called ‘portfolio working’, which may sound glamorous but actually means somebody working two or three or more different jobs, either to fit in with their lifestyle or to be able to guarantee a decent income. In addition many employees work in jobs that provide a basic salary with the opportunity to earn large bonuses, so they also have income patterns that place them outside of the norm.
People working in such circumstances do not want to be penalised because they have moved from job-to-job or because they have a spread of different income streams. What they need is a specialist lender that will take a considered view of their payment records and credit history and offer them a competitive mortgage.
Employment status will make up an important part of a customer’s personal circumstances, but this can be more than just income. For example, the number of divorcees who are specialist borrowers is more than double that found among mainstream customers. A divorce can have a major impact on a person’s credit status, perhaps because the separation has been costly and left them with debts, or because they have never held a mortgage in their own name before.
Again, just being divorced does not suddenly make a person a greater credit risk, but all too often it can mean they will find it difficult to qualify for a mainstream mortgage. The same goes for all manner of borrowers with different or complex needs, like renters that have moved from address-to-address and are now looking for a first-time mortgage, supporting right-to-buy customers getting on the property ladder or helping a buy-to-let investor build their property portfolio.
A sharper focus
In terms of income and affordability, mortgage regulation has brought sharp focus to this very important area. For specialist lenders this means being realistic about all the elements that make up an application, such as loan-to-value (LTV), multiple incomes from sources like a property portfolio or a pension.
Underwriting criteria for specialist lenders is often more flexible and pragmatic, so non-standard mortgage providers are more likely to take into account the borrower’s entire situation before making a decision, rather than being restricted to the narrow criteria that prime lenders often rely upon.
The same approach is applied to credit history, which, after all, forms the foundation from which the current specialist-lending sector has grown. In the early 1990s when people with poor credit histories struggled to get a decent mortgage deal, it was the specialist lenders that came along with an alternative based on competitive products and good service. Those principles remain today, particularly as the number of insolvencies in the UK begins to grow again. It is important that customers that have suffered from credit problems are able to find a competitive deal and get their mortgage and credit history back on track. Some fall foul of credit problems that are either historical, fairly minor, or, in some cases, caused by a former partner, but for which they continue to be penalised.
The situation is worsened by the strict credit scoring that most prime lenders employ – a ‘Catch 22’ that will reject anything that is not a scrupulously clean and prevent the customers from getting a decent deal to be able to rebuild their credit rating. Specialist lenders on the other hand make it their job to look beyond basic credit scores and assess the borrower on more relevant criteria.
Incorrect and insulting
So being a ‘specialist’ customer is not quite as unusual as many people would have you think. In fact the number of specialist borrowers that have non-standard factors such as being divorced or self-employed, far outweigh the number of customers with credit problems. These are the borrowers we would traditionally have called ‘sub-prime’, but as you can tell from the range of people that now regularly fall into the specialist mortgage category, to call them sub-prime is both incorrect and insulting.
Brokers intuitively have a great understanding of their clients and their clients’ needs, it is what makes intermediaries so important to specialist lenders. Now, with specialist lenders displaying the same level of customer understanding, those brokers have the tools and products available to ensure they can provide their clients with the right mortgage every time.
Ian Giles is marketing director at Kensington Mortgages
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