Sub-prime borrowers have never had it so good ‘ gone are the days when a letter of rejection from a high street bank automatically condemned borrowers to a hefty sentence with a lender which would charge whatever it could get away with.
Today, borrowers with County Court Judgements (CCJs) and arrears can take out a loan with an initial pay rate between 5% and 6% ‘ not hugely dissimilar to rates charged by high street lenders.
Clearly, the reductions to interest rates ‘ benefiting borrowers whatever their status ‘ has played its part but other factors are also at play ‘ namely competition. Sub-prime lending always used to be the realm of specialists, but with margins falling on prime business, many mainstream players have looked towards sub-prime as a means of diversifying their own portfolio and boosting their accounts.
Halifax, Abbey, Britannia and Bristol & West all now have an interest in the sub-prime market ‘ either through acquisition or the development of new lending operations. Not only has their arrival bought an air of respectability to the sub-prime market, they have also raised the stakes and it is borrowers who are reaping the benefits.
Brian Pitt, sales and marketing director at Future Mortgages, says: ‘Over the past year we have seen some aggressive discounts and some relaxing of loan to values and underwriting criteria.’
One product that stands out in terms of rate is a two-year fix from Birmingham Midshires, with an initial pay rate of 5.99%. The loan is available to 85% loan to value (LTV) for borrowers with up to £7,000 in CCJs and three months’ arrears in the last 12 months.
However, as Steve Sandiford, head of product strategy at Birmingham Mid-shires, explains, brokers may not always be able to rely on lenders to consistently churn out such competitive rates. ‘There is a big fight for distribution at the moment, the cost of funds has come down, so there will be some tactical pricing at the moment. We saw the opportunity to buy the funds and went for it.’
Although rates on sub-prime loans have shot down, Sandiford does not think they will fall much further. ‘This is about as low as these loans can go. Lenders still have to price for risk,’ he says.
However, it is not just rates that are looking good. Lenders in the sub-prime market are also beginning to increase levels of choice.
Guy Batchelor, sales and marketing director at Platform Home Loans, says: ‘Brokers want to be able to offer these borrowers a similar range of products they offer their prime customers. ‘
As a result, Platform is now offering three different discounts: a 1.5% discount until June 2003; a 1.75% discount until October 2003; and a 1.5% discount until April 2004.
Batchelor adds: ‘We are now concentrating on discount products following feedback from our intermediaries that their clients preferred these options.’
On top of more attractive incentives, sub-prime lenders are becoming more innovative and flexibility ‘ common in the prime market’ is slowly beginning to work its way into the sector, but as yet, it does not look likely to take off.
SPML and Mortgages plc are two sub-prime specialists that have ventured into this territory.
The move to flex
According to John Prust, sales and marketing director at SPML, the product has been a success. ‘This product has widened our portfolio and makes us into a more rounded lender ‘ it has increased our business substantially,’ he says.
Mortgages plc, meanwhile, has withdrawn its product, but has plans to redevelop and relaunch it at some stage in the future.
Clearly, there is a huge risk in offering borrowers with a questionable credit record the ability to vary repayments and it is for this reason criteria for the SPML product are tight.
Prust explains: ‘Our loan is only for people with minor credit problems ‘ literally those who fall just one step below the ideal client.’
But despite these precautions other sub-prime lenders are still sceptical. Pitt expresses his concerns: ‘Sub-prime lenders are there to help people who could not otherwise take out a loan and it is important to help them re-establish their credit profile. Giving borrowers the opportunity to underpay and take payment holidays is too risky ‘ these products could be fraught with problems.’
But that does not mean borrowers should never be offered flexible features. ‘Once borrowers have established a good payment record, it might be possible to flip them onto a flexible deal, but I would question the wisdom of selling it up-front,’ he adds.
Sandiford also has concerns, on the basis that sub-prime flexible loans would be incredibly difficult to underwrite. ‘Lenders are taking on an unknown risk when they allow borrowers to draw down capital and take payment holidays,’ he says.
Risk issues aside, Sandiford also questions whether payment flexibility is actually necessary in the sub-prime market. ‘Flexibility is becoming the norm on prime, self-cert and buy-to-let loans, but I am not sure how many people actually need flexible features ‘ in the sub-prime market the number will be even less.’
Mimicking the high street
Preferred Mortgages is also starting to mimic product offerings common to the prime market and is currently piloting a sub-prime shared ownership scheme.
Simon Biddle, marketing communications manager for Preferred Mortgages, said: ‘This has been due to feedback from our brokers and it also dovetails with the Government’s initiative on financial exclusion.’
Another area of product development has been the emergence of menu pricing, whereby lenders tailor their product to each individual applicant by looking at a series of factors such as the loan to value required, number of CCJs, arrears or whether they need to self-certify their income.
GMAC has pioneered this approach, however, Amber Home Loans and Pink have also ventured into this field with their Parachute mortgage.
David Copland, sales director of Pink, believes this could be the way the sub-prime market is heading. ‘We will see more pricing for risk where brokers can say to the lender ‘here is my client, these are his circumstances, what can you do?”
According to GMAC, menu-pricing is the fairest way of lending in the sub-prime market.
All sub-prime borrowers will have to pay a premium to get a mortgage, that is inevitable, but with menu-pricing rates are calculated according to the borrower’s own situation. ‘Borrowers like menu-pricing as it means they only have to pay for the credit problems they have,’ explains Gina Collman, head of corporate communications for GMAC.
Batchelor, however, is not convinced and believes the more traditional approach of ‘bucket pricing’, whereby the borrower is matched to the product that best matches their situation, should be sufficient.
‘There is such a big range of products available now that brokers can usually find their client the right deal,’ he says.
GMAC has been offering menu-pricing since 1998 and with only Pink and Amber following its lead four years on, it does not look as though menu-pricing is going to revolutionise the sub-prime market, despite strong sales among those lenders offering it.
Going forward one of they key areas for product development will be the march into light adverse. More specialist lenders are now developing products for borrowers that fall short of mainstream lenders’ requirements, but with only a few slips on their credit record should not need to pay over the odds for a traditional sub-prime loan, priced around the needs of borrowers with more severe credit problems.
Platform has recently launched a range of light adverse products, catering for borrowers that might have failed a credit score due to one or two financial hiccups. Batchelor says: ‘Our strategy is definitely to move up the credit spectrum. We found there was a gap between what was offered by sub-prime lenders and the high street. This range now accounts for 20% of our business.’
Mortgages plc is another lender to explore this market and Beaumont expects big things for the new range.
‘The development of light adverse reflects the changing dynamics in the market. It is the biggest growth sector at the moment ‘ not just for us, but for the market as a whole.’
Beaumont attributes this to growth in consumer debt. ‘By the end of 2001, the UK had £720bn worth of consumer debt, including mortgages. To put this growth into perspective this figure has grown by £100bn in the past two years alone.’
He adds: ‘This has created a large debt bubble and, as interest rates rise, it could burst and many people’s debts could spiral out of control. We need to design products to cope with this.’
Going forward, Beaumont also believes the growth in correspondent lending will help shape the products offered in the sub-prime market ‘ which he now believes is currently the largest growth area for sub-prime distribution.
‘Correspondent lending is an excellent platform for product development ‘ they have their own introducers with their own demands, a different approach to lending and can identify areas traditional lenders might miss,’ he says.
Preferred Mortgages has now arranged correspondent lending agreements with five packaging firms ‘ its Preferred Partners. Biddle explains: ‘We offer our partners the software to design products within certain parameters to meet their own requirements. It tips the packager-lender relationship on its head.’
For the future, it is clear that with so many different sub-prime lenders fighting for market share brokers can be confident of continuing attention to products that address the needs of a market that is continuing to diversify.
But a word of caution: while innovation may continue, with the economic landscape looking a little uncertain brokers can expect to not only see rates rise but lenders may also start to tighten product criteria to cover an increased level of risk.
Pitt says: ‘If interest rates rise and house prices begin to fall sub-prime lenders would be the first to restrict lending.’
Rachel Williams is editor
The current low cost of funds means there are some extremely competitive sub-prime mortgages available.
More sub-prime specialists are developing light adverse products to bridge the gap between themselves and high street lenders.
A rise in interest rates could prompt lenders to tighten product criteria.