A lurid headline can always be guaranteed to sell newspapers or for that matter any other publication, but it can often do more harm than good and can even become a self-fulfilling prophesy. It is worrying therefore that a well known independent market analyst recently reported what it considers could be a ‘time bomb waiting to explode’ if those with self-certification mortgages should face a downturn in the economy.
While it is true to say if interest rates went up considerably then many borrowers with self-certified mortgages would feel the pinch. But, then again, so would the majority of people with home loans. However, where the ‘time bomb’ scenario could be particularly misleading is the inference that large numbers of borrowers are using self-certification as a way of borrowing well beyond their means, with disaster lurking around the corner. This in turn seems to suggest that lenders who offer self-certification are being less than responsible with their level of advances ‘ and in most cases this just simply is not the case.
When self-cert is not self-cert
The key to any potential problems lies in the terms of the individual deal, because not all self-certification mortgages are the same. Many lenders offer self-certification mortgages that are actually nothing of the sort because the lender will then go on to ask either for bank statements supporting the claimed income or an accountant’s letter of serviceability. With true self-certification mortgages on other hand, the lender asks for no proof of income at all, and therefore it must be at this category of product that the ‘time bomb’ allegation is aimed at.
So, are lenders allowing people to put themselves in possible financial peril through the true self-certification system?
It may be useful at this stage to take a step back and look at the development of the market. The first UK lenders to launch into the market with true self-certification did so back in 1989. This means there has been14 years to assess the risk associated with allowing borrowers to certify their own income. On the basis of that evidence, self-certification has proved to be a perfectly acceptable business risk. That is why some non-conforming lenders have introduced a self-certification option on virtually all their mortgages.
In terms of risk to borrowers, it appears that there has been little to speak of so far, and arrears figures bear out that confidence. Figures from the Council of Mortgage Lenders (CML) show that arrears levels on self-certification mortgages are low, which suggests that self-certified borrowers are no more over-extended than those whose incomes are carefully vetted before loans are granted.
Presumably the faith demonstrated by non-conforming lenders in the basic financial common sense of the majority of self-certified borrowers is shared by the significant number of mainstream lenders who are now beginning to offer forms of self-certification.
But what of the future ‘ if rates do rise significantly, will the self-certified really be the first to get into difficulties?
The first thing to remember is the nature of the people who tend to use self-certification, as Rachel Pyne of Buildstore explains: ‘More often than not, the clients we do self-certification applications for will have multiple income streams. These could include income from more than one business, investment income and possibly further income from property rentals. This gives these people broad financial bases and so, if anything, they are more capable of withstanding future rate rises than those who rely on a single income.’
Lenders also build their own safeguards into self-certification mortgages. The obvious one is the maximum loan-to-value (LTV), which should generally be lower than that of mainstream mortgages. Clearly, any lender granting 95% LTV or more on a self-certification basis would be open to potential criticism. By limiting the maximum advance to 90%, the borrower has an equity cushion if things get tight further down the line. There is also a psychological factor: borrowers who have 10% or more of their own money tied up in a property will show much more commitment when it comes to keeping up their mortgage repayments.
Another way lenders can and should help to protect borrowers against over-extension is to make sure self-certification interest rates are realistic and fair. If self-certification mortgages can be offered at rates roughly comparable with mainstream loans, it means that borrowers do not start with a built-in disadvantage should rates rise significantly in the future.
Follow your instincts
Of course in the real world certain people will undeniably attempt to borrow far more than they can afford through self-certification. This is where an experienced lender’s underwriting instincts can help save individuals from themselves. To do this it is important that a prospective borrower signs a declaration of their income as part of their application. Occasionally, this declaration can ring alarm bells when, in the experience of underwriters, the person’s stated work activities would not normally generate the claimed income. It is rather like the way the Inland Revenue has bands of ‘normal’ income for given businesses and if someone claims to be earning less than this norm for tax purposes suspicions may be raised.
The subject of underwriters using their well-honed instincts leads onto the whole issue of individual underwriting, which most in this sector feel should be a fundamental part of the self-certification process. Every self-certified application should be considered on its merits rather than merely using credit scoring alone. This not only gives legitimate applications the best possible chance of success, but it also makes it much harder for any application based on a falsified income to get through the net ‘ protecting all concerned.
So far the debate has been focused on some of the factors that can limit a borrower’s exposure to rising interest rates ‘ but the fact remains that lenders are not here to enforce some sort of ‘financial nanny state’. Assuming all reasonable lender safeguards are in place, then self-restraint from borrowers must also play its part.
Phil Green of Mortgage Packagers Ltd, says: ‘The argument that clients who go for self-certification can be more vulnerable to future rate rises than mainstream borrowers is a bit simplistic. In the current ‘feel good’ climate there is nothing to stop a mainstream borrower with a 95% LTV mortgage running up a separate £20,000 debt on credit cards, for example.’
If borrowers are going to find themselves with debt that is unsustainable in the face of rising interest rates, they can easily do it without the help of self-certification. According to national statistics, unsecured personal debt such as credit cards and personal loans has now reached a record £140bn ‘ which is more than £2,300 owed by every man, woman and child in the UK.
If we accept successful self-certified lending demands a level of common sense from borrowers, then this should also extend to putting the right insurance cover in place. Which means brokers should automatically be discussing protection as part of every self-certification mortgage package.
There is another way people with self-certification mortgages can protect themselves against future rate rises and that is to opt for a flexible facility. While rates are at such low levels they can, if they wish, make overpayments to reduce their debt. Then, if times get harder, they can reduce their monthly outgoings or possibly take a repayment holiday to help weather the storm. A true flexible mortgage will also allow them access to their housing equity through drawdowns if needed.
The potential safeguard of flexibility is an equally valuable ‘bolt on’ for salary-certification mortgages which are increasingly popular. These are designed for employed people who want to declare a regular second income as part of their total income ‘ something many mainstream lenders will not allow.
So, in conclusion, 14 years of experience has shown non-conforming lenders that people with self-certification mortgages are no more likely to over-extend themselves than any other home owner. Lenders can help to ensure that self-certification mortgages remain sustainable in the face of rate rises by careful individual underwriting, by charging an interest rate comparable with the mainstream and by setting a prudent maximum LTV figure. Borrowers can also play their part in this sustainability by getting good insurance protection and by taking advantage of the flexible mortgage option.
Self-certification has so far proved a real winner for brokers, allowing them to solve mortgage problems for a whole range of clients who are ‘non standard’ in mainstream lending terms. If we continue to provide self-certification in a responsible way then there is no reason why many more people should not benefit from it, regardless of what interest rates do in the future.
True self-cert lenders still protect borrowers by limiting LTV, and keeping rates competitive.
Individual underwriting means that applications are still scrutinised for exaggerated income.
Making overpayments can be a vital insurance against rising rates and temporary unemployment in the future.