What is a non-conforming mortgage?
When talking about the non-conforming sector most people immediately think of sub-prime mortgages. Essentially a sub-prime mortgage is a home loan for borrowers who have potentially problematic issues, either because they have defaulted on their mortgage before, have debt or credit problems, or have an irregular income. In the (now distant) past this meant borrowers had been turned away from mainstream lenders and had to settle for a sub-prime alternative, often with very high rates of interest. As a sector of the mortgage market it had a very poor reputation and was normally seen as an option of last resort by many people
Over the last ten years or so, however, the sub-prime market has not only become much more respectable, it has also expanded to offer a wider range of mortgages to even more borrowers. It now encompasses numerous markets such as self-certification, buy to let and right to buy. As a result non-conforming lending is now a term that is widely used to refer to the specialist sector, and the difference between it and traditional prime lenders is reducing all the time. Non-conforming mortgages are now available for borrowers who might have only minor credit problems and are not truly high risk, but who would be rejected by high street lenders.
What prompted the growth of the sub-prime sector?
The development of the sub-prime sector has run parallel to shifts in the prime sector, often capitalising on the changes occurring in the traditional marketplace. The housing and economic boom of the 1980s led to escalating house prices and a stream of borrowers attracted by low interest rates.
When the economic bubble burst, the 1990s saw rocketing interest rates and growing unemployment, coupled with falling house values. Many homeowners could not afford their mortgage repayments but were stuck in a negative equity trap that meant they could not even sell their homes to find more affordable properties. This meant lots of borrowers found themselves in a downward spiral of serious arrears and repossession.
After getting their fingers burnt in the resulting crash, the high street lenders adopted a more cautious approach to borrowers, refusing to give mortgages to anyone but rock-solid financial cases, and fighting shy of borrowers with a hint of bad debt. This left the door open for new entrants into the mortgage market, mostly from the US, who plugged a gap by realising that by taking on higher risk borrowers, they could charge much higher interest rates and fees, and claw in big profits.
How did sub-prime change its image?
Kensington is the company most often cited as the lender that made sub-prime more respectable in the 1990s by offering mortgages for risk adverse borrowers at affordable rates. This was soon followed by a raft of lenders who also offered products that took a much more sensible view of higher risk borrowers, mortgages with interest rates structured depending on the level of risk as well as normal values such as LTV and amount of deposit.
In recent years mainstream lenders have been waking up to the potential of the non-conforming market – for example, the Britannia Building Society acquired sub-prime lender Platform and merged it with its own specialist lending arm, Verso. A more recent example has been Bristol & West’s partnership with Mortgages plc, where the building society’s non-conforming borrowers are offered with loans underwritten by Mortgages plc.
Today the non-standard mortgage market, which includes sub-prime business along with niche products such as buy to let and self-certification, is estimated to be worth in excess of £15bn, double the size it was in 2000.
How does the non-conforming sector differ from prime?
The most obvious difference for the lender is that non-conforming mortgages tend to be more complex and therefore until now have tended to be individually underwritten rather than credit scored like standard mortgages.
Intermediaries are particularly important to the non-conforming sector because they play a vital role in advising, identifying and explaining mortgages that can be extremely complicated to understand. The vast amount of non-conforming mortgages are dealt with by intermediaries. As a result of the additional workload involved with these mortgages, brokers are paid higher procuration fees on sub-prime deals than on prime business.
A whole industry has grown up around the sub-prime sector, the most obvious of which are the packagers who form a vital link between the broker and the lender, collecting all the additional information and paperwork from the borrower to complete the deal.
What’s the future of non-conforming mortgages?
The initial anxiety within the industry over the Financial Services Authority’s upcoming mortgage regulation has given way to a more confident mood as many organisations respond by tailoring their businesses to offer more products and better services.
Packagers are now becoming distributors and are offering brokers a vast array of non-conforming mortgages, many at preferred rates, or special products bundled with additional features. .
A major impact of IT will be the introduction of US-style credit checking that will enable brokers to give borrowers on the spot decisions about loan applications. GMAC RFC for example is currently trying out a point-of-sale system where the broker asks the borrower a series of questions relating to their credit history and income. This information is then immediately cross-referenced against a credit database and a lending decision is usually made within minutes. The application still needs to be checked by an underwriter, but a lot of the legwork at the start of the process is removed.
In short the future of the non-conforming sector is bright because it is an industry that is driven by innovation. It is a market that thrives on creating solutions to an ever increasing number of complex situations for a growing number of borrowers.