Will mortgage reforms kill off the recovery?

The City watchdog is set to shake up the UK home loan market. What will this mean for buyers and sellers?

During the property boom earlier this decade, the British mortgage market was infected by fraud and poor lending practices. Brokers and borrowers were exaggerating earnings, while lenders often neglected to make sufficient checks as to whether the person taking the loan could repay it.

Meanwhile, the regulator, the much-criticised Financial Services Authority, is widely regarded as having failed to get a grip until it was far too late.

Now the FSA is set to outline a series of reforms to the industry in a report to be published this week. But what will it mean to you, the consumer? Will it improve the dire situation in the mortgage market or could it halt the house price recovery?

Among the expected reforms, the FSA could put the final nail in the coffin of self-certificated mortgages by establishing a rule that will compel lenders to insist that their customers provide clear proof of income.

“The capital resources of lenders will also be considered, setting new levels to be adhered to,” says Melanie Bien from mortgage broker Savills Private Finance. “It is also possible that the FSA will look to regulate currently unregulated areas, such as buy-to-let and second-charge loans. And the riskiest areas, such as self-cert loans, are likely to disappear.”

These self-cert mortgages, which do not require applicants to prove to the lender how much they earn, were initially marketed to self-employed or contract workers who find it difficult to secure a mortgage because of an irregular income. However, many other borrowers who were rejected on industry standard income multiples were instead offered these mortgages, allowing them to borrow up to five times their income. As a result, these mortgages were labelled “liar loans” and have been blamed for many bad loans at both HBOS and Bradford & Bingley.

Although once a booming part of the mortgage market, the number of self-cert loans has plummeted in the past two years. Back in 2007, 23 per cent of residential mortgages were available through self-certification, according to financial information service Moneyfacts. Now, after the Mortgage Works pulled its remaining self-cert products last weekend, only one high street lender, Platform, part of the Co-operative Bank, continues to write this type of loan.

Despite this, many experts agree that self-certification is not a bad product and could have served some borrowers well if it had been used correctly. If self-cert loans do disappear entirely, some self-employed individuals may find it next to impossible to secure a mortgage. “There would have been a place for self-certification mortgages in the market, but only if the product was prudently assessed for realistic declarations and sold to people whom it was originally designed to assist in the first place,” says Darren Cook from Moneyfacts.

Another potential feature of the FSA’s review could be a recommendation that buy-to-let mortgages are included within its remit. In 2004, when the FSA took over responsibility of mortgage regulation, buy-to-let mortgages were not part of its regulatory scope because they were deemed to be investments.

“Regulating the buy-to-let market is a fair point and something the industry should probably welcome, but I want to see the FSA come out with some sensible rules that will actually help the industry and, more importantly, the client,” says Andrew Montlake from mortgage broker Coreco.

Experts warn against any regulations that are too reactionary because they could pose problems for consumer and lenders alike. There is also hesitation when it comes to the introduction of formalised limits on income multiples and limits on higher loan-to-value (LTV) lending. In March, Lord Turner, the chairman of the FSA, hinted at the possibility of capped LTV ratios but property experts were quick to warn that this would only damage the market further by allowing already reluctant lenders to restrict access to finance for all but the elite borrower.

“Limiting something like income multiples could leave existing borrowers out in the cold. Self-certification is virtually a closed market now and high LTV lending has also disappeared as lenders have focused their best rates on borrowers with big deposits,” says David Hollingworth from mortgage broker London & Country.

Along with the potential for big changes after this week, there is considerable uncertainty about how the property market will shape up over the next few years and how the FSA reforms may affect recovery.

Although some people have predicted an imminent property purchase revival with the number of loans approved for house purchase at 53,000 in August, up 29 per cent on last year’s figures, we are still a sizeable way off the average August figures of 100,000 seen in the seven years before the credit crisis. Moreover, remortgaging activity remains subdued according to figures released by the Council of Mortgage Lenders (CML) last week. The number of remortgage loans fell to 32,000 in August, a 22 per cent fall from July and a 57 per cent decrease on August last year. The decline in the remortgaging market is a result of low interest rates, making it cheaper for many homeowners coming to the end of cheap fixed-rate deals to move on to their lender’s standard variable rate, rather than remortgaging. And restrictive lending criteria have resulted in homeowners unable to secure a remortgage because they do not have enough equity in their homes.

“The pendulum has swung and the problem is the lack of available mortgage finance,” says Michael Coogan, the director general of the CML. “Regulatory intervention on mortgages is unlikely to reverse this trend and may accentuate the problem.”