Avoid a sub-prime crisis

Sub-prime (also known as ‘adverse-credit’ and ‘non-conforming’) mortgage lending has escaped from the mortgage magazines and on to the front pages in the past few months. Problems in America have infected lenders in the UK, with Northern Rock dominating the news when it was forced to turn to the Bank of England for financial protection.

But what is really going on, and how do all the horror headlines affect potential borrowers?

What is sub-prime?

The first thing is to remind ourselves of what sub-prime is. In simple terms it refers to borrowers with less-than-perfect credit histories or who do not fit into lenders’ mainstream borrowing criteria. It’s also sometimes known as adverse credit lending.

The phrase encompasses everyone from the self-employed to people with county court judgments (CCJs) against them. Prime borrowers are those in full-time employment, with a regular income and a proven ability to repay loans. Everyone else falls into sub-prime as lenders will be more wary about them.

“Sub-prime loans are for those who can’t get a mainstream or prime mortgage,” explains Melanie Bien of mortgage brokers Savills Private Finance. “This may be because they have missed mortgage payments in the past, have a poor credit history such as CCJs, or have been declared bankrupt. The idea is that after a period of time on a more expensive sub-prime rate people will be able to ‘clean’ their credit history so will be able to get a standard prime mortgage.”

The sub-prime concept took off in the UK in the early 90s as new lenders, such as Kensington, tapped into the growing market for people who didn’t fit exactly into high street lenders’ view of what a good borrower should be. To a degree, the new-style lenders simply reacted to a changing workforce with more people becoming self-employed or contract workers, for instance, who would have been turned down for loans.

In time the high street lenders realised they needed to be more flexible with their lending decisions and so sub-prime became more mainstream. Now some 54 lenders offer specialist mortgage products – up from just 24 two years ago.

But the rush to get into sub-prime brought its own problems, according to Ian Giles of specialist lender Kensington Mortgages. “Many new lenders battled aggressively for market share, using criteria and price, but there have always been doubts over the sustainability of this tactic, and it is likely that several of these late entrants will be forced out of the sector by the market correction now taking place.”

There’s a price to pay

In the past, sub-prime borrowers have been charged more for loans as they represented greater risks. But in recent times, especially in the States, sub-prime lending became more competitive and rates dropped as lenders chased customers.

The net result, over there at least, was that several lenders handed out riskier loans and then saw an increase in defaults, as fewer customers repaid the loans.

The US problems have had an effect on the UK market as several lenders have exposure to American borrowers. The net result is that British lenders are raising rates and being harsher when it comes to lending to people with a less-than-perfect credit record.

Getting a mortgage

“Borrowers with an adverse credit history will find it more difficult to get a mortgage if they do not have a 25 per cent deposit, or equity built up in their home,” warned Giles.

The gloomy short-term picture for the UK sub-prime market has seen specialist lender Victoria Mortgages going into administration, Northern Rock being supported by the Bank of England, and many other lenders having to pull products and increase rates.

“It is almost impossible to get a clear idea of what’s on offer in the adverse credit market at the moment, with people withdrawing deals on a daily basis,” says Giles.

“I would advise people to go to a regulated mortgage broker, or maybe two, to compare the advice they have been given, and be totally honest about the credit problems they have had. Brokers will be able to advise them what’s on offer, given their situation. There is virtually an individual price for each borrower in this sector right now.”

His view is backed up by Melanie Bien at Savills. “It is now much harder for someone with a chequered credit history to get a sub-prime mortgage than it was before August. Rates have risen, lenders have reduced maximum loan-to-values, and some have refused to lend to first-time buyers or those borrowing on a self-cert basis.

“Lenders here have become more cautious and in some instances have priced themselves out of the market for now. It is important for borrowers who think they may need a sub-prime deal to use a broker, as brokers may be able to find them a prime mortgage, which will inevitably work out cheaper.”

Andrew Hagger of rate analyst Moneyfacts reports that interest rates are being increased and loan to value restrictions being tightened – in other words, borrowers are being asked to have a higher deposit.

“There is a vast and potentially bewildering range of sub-prime mortgage products available, mostly through specialist lending arms, so it is important that you use an IFA or broker to guide you through the maze to ensure you get the best deal for your own particular circumstances,” he advises.

But don’t rule out the high street lenders, Hagger says. “If you only have very minor blemishes on your credit record, you may find that some of the high street lenders will still accept you. For example, if you have a CCJ of £250 or below, Nationwide Building Society may still consider you for a prime mortgage. Similarly Yorkshire Building Society may consider you if you have no more than two CCJs and up to £500 maximum, as long as none of the CCJs were in the last year.”