Sub-prime is a dirty word in the mortgage market in the wake of the credit crunch, but with the big lenders ignoring all but the perfect borrowers, many creditworthy homeowners risk being unfairly labelled and unable to get finance.
Borrowers with irregular incomes, or imperfect credit ratings, with any history of missed credit payments, are being ignored by the bulk of the high-street lenders.
This comes at a time when things are already tough, with the number of mortgages written last month by the six largest high-street lenders 26 per cent lower than a year before, according to the latest figures from the British Bankers' Association (BBA).
In general terms, sub-prime lending refers to high-risk borrowers with unfavourable credit histories, often because of county-court judgments (CCJs), Individual Voluntary Arrangements (IVAs), bankruptcy, or arrears on a mortgage or any other defaults on credit commitments. When the credit crunch hit, lenders took swift action to limit the mortgages available by dropping loan-to-value ratios (LTVs) and tweaking credit scoring systems to control the number and quality of borrowers accepted.
"Sub-prime was seen as one of the main causes of the credit crisis and, as the riskiest type of lending, it was one of the first markets to disappear. The last sub-prime deal was withdrawn on 27 May 2009," says Michelle Slade, from financial comparison site Moneyfacts.co.uk.
As a result, lenders are employing tougher criteria to determine how risky a borrower is, and although many lenders would have once forgiven a few blemishes on a credit record, now only pristine borrowers are getting the best rates. Combine that with a record low number of mortgages being written last month and the possible threat of a double-dip recession, and some borrowers who would have been considered prime a few years ago, are now finding they are being rejected by the mainstream market.
"In most instances those that now find themselves as sub-prime due to criteria changes, or those that are coming to the end of an old sub-prime deal, have little option but to remain on their existing lenders' revert rates until their credit scores improve and they can re-enter the market as mainstream borrowers," says Ms Slade.
With big players such as Santander, HSBC and Nationwide dominating the residential sector but competing for the same "perfect" borrowers, the fear for many homeowners is that they are being unfairly left out. But one ray of hope is that, because the high-street banks are cherry-picking the safest borrowers, this has left a gap for smaller lenders entering the market to concentrate on those who just miss out.
This week, specialist lender Precise Mortgages gained approval from the Financial Services Authority (FSA) to provide residential mortgage finance. At present, the group only lends to buy-to-let investors, a sector not regulated by the FSA, but it will launch a series of mortgage products to homeowners from November and, crucially, the lender has said it will focus on borrowers who do not meet the strict criteria of the main high-street banks.
"We are seeing some lenders, like Kensington, Aldermore, GE, Platform and now Precise Mortgages, that aim to offer something a little outside the standard lenders' criteria, although it's a far cry from the traditional definition of sub-prime," says David Hollingworth of mortgage broker London & Country.
Specialist lenders could be the only option for those who don't fit the "perfect prime customer" bill of being a salaried employee with one income, living at the same address for at least three years and maintaining every payment on every credit commitment.
"Conditions are likely to be difficult for some years. Until funding returns to the market, lenders are likely to shun those with credit problems, and even those with just a missed mobile phone payment will struggle to get funding," says Melanie Bien of mortgage broker Private Finance.
Where specialist lenders can step in, is for those who fall just outside of this strict definition, such as the self employed, those working to a commission or bonuses, or those with an incomplete credit history, but who can still prove themselves to be responsible, creditworthy individuals.
The benefit of specialists is that they are more likely to take homeowners on a case-by-case basis. So, although having a record of arrears will mean automatic rejection from big lenders, smaller specialist lenders will use underwriters who can take other factors into consideration.
Platform allows up to £500 CCJ (although none in the past 12 months) with its Almost Prime range, and Kensington will accept missed payments up to two minor defaults in the past two years as long as the borrower has been up to date in the past six months. "The main difference between Kensington and the high-street banks is that we view each case on its merits instead of using credit scoring where each application is attributed a score in terms of risk profile, and if you're above that score you pass, or below and you fail," says Alex Hammond of Kensington Mortgages.
The big question, however, is whether borrowers will have to pay through the nose for this.
Aldermore is one new entrant into the market this year that has made a point of offering mortgages to borrowers rejected by mainstream lenders. Its residential range includes a two-year tracker at 3.98 per cent for 65 per cent LTV, and a three-year fix at 5.28 per cent for 75 per cent LTV.
When compared with the best of mainstream offerings such as First Direct's two-year tracker at 2.19 per cent for up to 65 per cent LTV, with a £99 fee, or the three-year fix at 3.49 per cent for those with at least 25 per cent deposit from Mansfield Building Society, with a £999 fee, it's clear that there is a premium to pay.
At Kensington, residential mortgages have recently been cut and now start from 4.7 per cent for a two-year fix up to 75 per cent LTV, and 5.44 per cent for up to 80 per cent LTV. Again, there are much better deals in the mainstream market, such as the 2.89 per cent two-year fix from Yorkshire BS, available up to 75 per cent LTV, with a £495 fee, or the Post Office's 3.45 two-year fix available to those with a 20 per cent deposit, which levies a £995 fee.
The only other option for borrowers struggling to get finance is to hold tight and try to improve their creditworthiness before applying again.
"The key is repairing the credit profile by getting up to date and building a good track record for future mortgage applications," says Mr Hollingworth. "As for all borrowers, having as big a deposit as possible will help."
David Hollingworth, London & Country
"In the short to medium term, the focus from most lenders will be on low-risk, plain-vanilla lending. Beyond that, the new lenders that are entering the market should bring some new approaches to niches that fall just outside although are very much at the prime end of the market."