Mortgage advisers love to have clear cut answers to all the queries raised by their clients, and individual lenders can usually provide clear and detailed information about their own products and criteria. However, when it comes to making industry-wide generalisations, this information is more difficult to provide, particularly in the area of impaired credit.
Obviously, mortgage applicants who have been refused a loan by a mainstream lender and are now looking at what niche lenders have to offer will be asking some tough questions. Why was their original application declined? When will they be able to remortgage, and how quickly can they shake off their bad credit rating?
However, there are no easy answers to these questions, as each lender takes a different view about the particular ways of measuring the risk associated with adverse credit.
This is because the lender’s whole system will have been built on a set of subjective judgements about what type of borrower is likely to make regular repayments and which sort is not. It is all about individual lenders taking calculated risks, and some have more appetite for this than others.
The borrower who has an exemplary credit record and pays their bills regularly will be at the top end of the scale. The tricky part comes when a borrower has had a few financial hiccups, possibly resulting in arrears, county court judgements (CCJs) or bankruptcy and, as a result, gets rejected by their chosen lender’s credit scoring system. As these systems are designed as an overall framework producing a composite rating, the borrower whose application has been declined can never be sure which bit of their credit history tipped the balance against them.
However, lenders who are prepared to take on borrowers with a past history of credit and payment problems need to set some markers for the range of risk they are happy to work with. These bands are, almost without exception, expressed in terms of the three official consequences of poor credit management: arrears, CCJs, and bankruptcy or an individual voluntary arrangement (IVA). Before looking at what sort of combinations of these factors are acceptable, and which are considered the most seriousš it will be interesting to see the recent history and current state of these market conditions in the UK.
Let us take CCJs first: in 1993, 1.8 million CCJs were registered, against a backdrop of interest rates as high as 13%, a collapsing housing market, and a rising flood of unpaid debts. However, by 2001, CCJs had declined to 837,600 ‘ a mere 46% of the level a decade or so earlier. Recent steep declines in CCJs have been triggered by the civil justice reforms of 1999, put together in Lord Woolf’s report Access to Civil Justice. These measures were designed to reduce civil litigation and introduce a less adversarial and more co-operative climateš into the process. For example, the system of ‘pre-action protocols’ requires creditors to contact debtors in a spirit of promoting settlement, rather than resorting to the courts for judgement.
Mortgage arrears are also in sharp decline: about 143,000 accounts were in arrears of three months or more at the end of 2001, compared with 510,000 in 1993. The economic climate of steadily falling interest rates combined with the increased take-up of debt counselling has undoubtedly contributed substantially to this 72% drop in arrears levels over the past eight years.
Bankruptcy and IVAs are the only factors showing a steady increase. Reversing a steady fall in numbers from 31,000 in 1993 to 19,500 in 1998, the past three years have seen an overall increase of 19.5 % to the 2001 level of 23,500 bankruptcies. Likewise, IVAs have risen sharply from just below 5,000 in 1998 to an average of just over 7,000 a year over the past three years. This seems to contradict the falling trends in CCJs and arrears.
One can only speculate that bankruptcy is becoming an increasingly acceptable route to clearing personal debt ‘ especially as the Government wishes to de-stigmatise bankruptcy to boost entrepreneurship, as set out in the Department of Trade and Industry’s Enterprise Bill, which is currently before Parliament.
Conversely, the underlying cause of CCJs is on the increase. Consumer debt (excluding mortgages) now stands at £177bn (up from £115bn in 1999), and the total value of student loans issued in the year 2000/01 was £2.2bn ‘ a substantial debt burden to take forward at the start of working life.
So assuming the debt burden will ensure a steady stream of mortgage applicants needing a sub-prime/credit impaired mortgage in the future, how does the hierarchy of personal credit history work, and how long does it take for a sub-prime borrower to create a healthy credit profile?
Wiping the slate clean
Regarding the scale of gravity of sub-prime factors, common sense dictates that arrears (missed payments) are at the lower end of the scale, whereas IVA and bankruptcy are at the more serious end.
However, where people have experienced a period of credit difficulties, they often tend to have some recent arrears combined with CCJs and possibly a discharged bankruptcy in the past ‘ rather than an isolated CCJ or couple of arrears. Therefore, there is no uniform method of assessing their credit risk. More often lenders create mortgage schemes that take account of different combinations of circumstances. Apart from the adverse credit circumstances, these combinations will include other factors that affect perceived risk ‘ for example, the level of LTV required, and the amount of documentary proof of income that the applicant is able to provide. The final piece of the jigsaw ‘ the margin above London inter bank offer rate (Libor) that the borrower is required to pay is the real indicator of the level of risk that the lender believes is inherent in each set of borrower circumstances.
Here are a few examples. At the lowest level of risk ‘ and therefore with interest payable at the lowest margin above Libor ‘ would be an applicant who needed to borrow no more than 65% LTV and who could produce references or statements showing a 12-month record of regular payments to their current lender or landlord. They would have missed payments of no more than two in the past 12 months and one in the last six months; registered CCJs of no more than £3,000 in the last three years; a discharged bankruptcy and/or an IVA that was operating satisfactorily.
At the top end of the risk scale would be an applicant who needed 90% LTV and who could produce the same 12 month record of payments and the same level of missed payments. The amount of registered CCJs within the previous three years, however, is higher at £5,000, but conversely, any bankruptcy order or IVA must have been discharged/satisfied at least one year ago and they must be able to provide documentary proof of income. Somewhere in the mid range of schemes, the borrower would need no more than 80% LTV; could self-certify income; have CCJs registered up to £10,000; and have missed four payments in the last 12 months and two in the last six.
So it is plain there is no simple answer to the hypothetical borrower questions posed at the start of this article. Just how soon a sub-prime borrower becomes acceptable to mainstream lenders depends on the current credit policies of those lenders, as well as on the borrower’s efforts to put their past credit problems behind them by establishing a regime of better financial control for their personal income and expenditure.
The borrower represents less of a risk because the time that has elapsed since the original adverse credit factors occurred lengthens.
Fortunately (for both borrowers and lenders), the use of counsellors to help with personal financial planning is becoming a far more widespread practice and we have found regular use of counselling at the first missed payment is extremely helpful in preventing mortgage arrears building up.
Often, a period of poor credit history is caused by a one-off event such as divorce, redundancy or a major illness, and the ability to take out a mortgage (albeit at a slightly higher rate of interest than a mainstream loan), enables borrowers to build up the pattern of regular payments that will once again establish them as a mainstream mortgage candidate.
Stuart Aitken is director of credit at Southern Pacific Mortgage Limited (SPML)
The speed at which sub-prime borrowers become acceptable to mainstream lenders will depend on their own efforts and the policies of the new lender.
Credit problems that are the result of a one-off event are the easiest to repair, such as illness or divorce.
Although levels of arrears and CCJs have fallen, the number of bankruptcies is steadily rising.