Without the sub-prime borrower where would the mortgage broker be? Sub-prime is the comfort for those who thought the prime market was slipping away.
But this market is said to be under threat itself as borrowers build better credit histories. As a result, we are seeing mainstream lenders starting to paddle in the pool. But before you rush for the lifeboats there are positive signs for the broker in a market less sinking than bobbing over a number of varying waves.
It is estimated there are 7.9 million people in the UK who would be refused credit from a mainstream lender. This represents £16bn of potential business. These figures are from research analysts Datamonitor’s report on UK non-standard and sub-prime lending for 2001. The report points out that take-up of mortgages in the non-standard population is less than the prime market (19.5% of non-standard household mortgage bought compared with 41.8% across the UK as a whole), but estimates the market to currently be worth £11bn.
Looking to the future, Datamonitor estimates that by 2006 the non-standard population will be between 6.7 million and 7.5 million, depending on how conditions improve in the UK economy. This fall in non-standard category borrowers will be due to a combination of improved economic conditions, for example fewer county court judgements (CCJs) and fewer mortgage arrears ‘ all trends which we are already seeing.
However, trying to see the potential for the sub-prime market is tricky. This is largely due to confusion as to what sub prime is. It is increasingly difficult to define the sub-prime market. Blurred as the definition is becoming, we see those with bankruptcies and serious arrears catered for more readily and the self-employed and contract workers ‘ who are not what would have originally been considered sub-prime ‘ nevertheless falling short of the criteria demanded by high street lenders. With such fine lines operating, is the sub-prime market growing because more people are self-employed, work part time, or work on contract? Or is it contracting because more people are escaping the consequences of negative equity?
A change in opinion
The market appears to be one that is developing, not because more people are struggling, but because the perception of the market is improving from the point of view of lenders and advisers. More people are seen as potential customers in the market because they do not fit standard lending criteria, not because they are a poor risk. It is this attitude that will help the market grow.
‘A key development is the mainstream lender’s view that sub prime is not dirty lending, that pricing for risk is fine. We have taken the view that while it is riskier and we will charge a different price, fundamentally it is still mortgage lending ‘ you approach it in the same way as you would any other customer,’ says Stephen Sandiford, head of borrowing products at Birmingham Midshires.
Some mainstream lenders and other financial companies have entered the market through acquisition as contenders pick up those niche companies with experience in the market. For example, Platform Home Loans has been bought by Britannia and First National is part of Abbey National. Future Mortgages belongs to Citigroup and igroup has recently been bought by GE Capital. HBOS has also entered the market via its subsidiary Birmingham Midshires Solutions.
It is understood that whatever the attractions of the sub-prime market it is highly specialised and that to play in the market you need more than a shop front and plenty of capital.
‘Some of the high street players have attractive rates, but they do not have the skills to underwrite and convert the enquiries they get,’ says Guy Batchelor, sales and marketing director of Platform Home Loans. ‘Players who have been in the market longer can underwrite and will not just cherry-pick the best cases. Also if you do not have the correct reward for risk you are not going to be in this business for long. There were a lot of self-certified lenders at the end of the 1980s, then in the early 1990s many went out of business because they were not charging the correct rate.’
Along with the new players one of the market’s latest developments has been the improvement in rates, which is good for clients as it keeps the market competitive. Just how far sub-prime rates can move in line with prime rates is yet to be seen.
‘It would be dangerous to say there would not be a difference in prime and sub-prime rates,’ says David Copland, sales and marketing director at Pink Home Loans. ‘Lenders would be mad to be writing mortgages for people with adverse credit at the same margins we are seeing in the sub-prime market. In fact, the prime market margins are unprecedented at the moment with lenders having to work on 1% or below. We will not see the sub-prime market get that competitive ‘ people would just bail out of it. But we will see pressure on margins and therefore the customer will get the better deal.’
Brokers will also appreciate the steps lenders have to take to maintain their position in the market, but still have to advise on sensible borrowing and understand that rates are not everything.
‘The more lenders you get in there the more competitive it will get,’ admits Sandiford. ‘Sub-prime lenders are becoming more innovative ‘ they are having to show more appreciation of what the customer and the broker wants because it is still primarily the broker’s market. Lenders are having to position themselves to what the brokers want.
‘Obviously no broker will recommend a lender offering 11% over one at lending 6% or 7%, but it is not as simple as price. It is also about long-term value. Some lenders are offering some very big discounts, but we will charge a fair price in the beginning because we do not want to attract sub-prime customers into something they think they can afford, but later becomes a problem for them.’
Birmingham Midshires has loyalty steps built into its schemes so borrowers that demonstrate a good payment record have their rate dropped. This shows the continuing importance of reward for risk in this market. But Midshires is also making the product simpler for clients in the form of rates linked to bank base rates (BBR) rather than Libor.
In terms of how the market is defining itself we are seeing products that take the market in opposing directions.
Two providers, Mortgages plc and Southern Pacific Mortgage Ltd (SPML), are running flexible sub-prime mortgage products for those with less than perfect credit. Both protect themselves against the potential risk of their targeted borrower, by only allowing the flexible options such as underpaying and payment holidays to apply once, or when borrowers have a surplus on their account. This meets the most obvious concern about having flexible sub-prime products, that people with a poor financial management history are given the tools to repeat that history.
Then there are the light adverse products for borrowers with historical arrears or CCJs ‘ those who have overcome credit problems and have a good track record over the last 12 months.
Platform Home Loans and most recently Mortgage Express have launched products for these clients. Mortgage Express also links to the Bank of England base rate and will allow certain customers the flexible options of over and underpaying, or taking a payment holiday or cash.
So, if not in decline, sub-prime is in some state of flux as various borrowers and lenders jockey for position. This is likely to continue for the next year at least with some inherent uncertainty.
‘We will see more consolidation and pressure on margins, which may see some independents bail out as they have not got the back book which the larger lenders rely on,’ says Copland. ‘We will also see more transparency in terms of rates ‘ the bank base rate is better because the client knows the margin they are paying over bank base rate and what sort of reward they will get if they are a good payer,’ he adds.
Sandiford says: ‘With sub prime the issue is more about the economy,’ says Sandiford: ‘Most people in sub prime over the last few months are those who suffered in the downturn in the early 1990s with bankruptcy and CCJs. Obviously we have been in a more benign economic situation for the past few years, so temporarily there are fewer people who would be considered sub prime. But what if the recession we are in, or threatened to be in, really does bite? Perhaps the pure sub-prime decline is only temporarily contracting.’
The future is bright for advisers in the market, as there is a definite need for advice. The mortgage broker is under no more threat from high street lenders entering the sub-prime market, than the prime market.
He adds: ‘I still believe it will be a broker market, because these people do need the advice and professional brokers to steer them in the right direction. It’s not just about the mortgage, it’s about the whole package of looking at a client’s finances and making sure that they understand what they are doing. The sub-prime market is complex and customers are better served by the broker.’
Stephanie Spice is a freelance writer
An improvement in rates has been one major development in the sub-prime market.
Through acquiring experienced niche companies, mainstream lenders have got a free ticket into the market.
Over seven million people in the UK would be refused a loan from a mainstream lender due to their poor credit history.