Sub Prime Mortgages And Home Loans

If you have happened to read any of the financial press, or turned on the television news in the last few months, you can't have failed to notice articles about the crisis facing the Sub-Prime mortgage or home loan market, both here in the UK and particularly in the US. So what are the actual problems facing this growing sector of the market and will the situation in America soon be reflected in this country?

Firstly, it's probably worth briefly talking about what a Sub-Prime mortgage actually is. Traditionally when somebody applied for a home loan, a credit check of some form or other was carried out against their personal circumstances. If any gremlins turned up, such as loan arrears or county court judgement, invariably the client would be declined the home loan. As we currently live in a world of credit cards, loans and HP agreements, inevitably some consumers, for various reasons, fall behind with payments and find themselves with a poor credit rating. This is an ever increasing situation in the UK today, with more and more people being unable to service their outstanding credit commitments. This is how the Sub-Prime market was born. Initially, anybody with a less than perfect credit rating fell into the all encompassing category of "Sub-Prime", or as it used to be called, "adverse credit".

Nowadays, as more and more customers find themselves with credit problems, the Sub-Prime market is becoming increasingly sophisticated, with products to suit an individuals personal circumstances. These range from "near prime" or "light adverse" for someone with very minor problems, all the way through to "heavy adverse" for those customers with a large number of CCJ's or several months previous mortgage or loan arrears, with several levels in between these extremes.

There are several reasons why the Sub-Prime mortgage market is receiving all this bad press and facing the problems that it has. Firstly, as the sector has grown, an increasing number of lenders have entered the market, leading to more competition and a relaxing of lending criteria, which makes it easier to obtain a loan. Secondly, the Financial Services Authority, who regulate mortgage activity, have raised concerns over some mortgage advisers failing to adequately assess customers' ability to afford the mortgage and also with some lenders themselves, who have not adequately covered the relevant responsible lending considerations in their policies. The final straw for many has been a steady increase in interest rates, from 4.5% in August 2006 to 5.75% in July 2007. This has led to increased mortgage payments and already overstretched budgets being pushed to breaking point, with the end result of a greater level of mortgage arrears and repossessions. With house prices showing signs of falling and the possibility of another interest rate rise in the near future, the situation is likely to worsen over the short term with more repossessions and the possibility of negative equity for many borrowers.

As we know, what happens in America is usually reflected in our own markets within a few months, so, with the close ties we have in this country with the US, is our Sub-Prime mortgage market about to take the same downward spiral currently being suffered by the Americans? According to many experts in this country, including the Council of Mortgage Lenders and various specialist lenders, the cautiously good news is, this is not likely to be the case.

Although the outlook for the Sub-Prime mortgage market in the UK is gloomy and there are many similarities between ours and the US market, there are also a great number of differences. One main reason for the impact of this sector on the US is that Sub-Prime lending accounts for almost a quarter of the American mortgage market, whereas in Britain, Sub-Prime only accounts for 6% of the overall mortgage market. Another major difference is that lending criteria in the US was relaxed more than it was in the UK, with lenders not verifying borrowers' income and allowing greater loan to value levels, even up to 100% LTV! In the UK, the maximum loan to value for a Sub-Prime mortgage is typically 85-90%, with the average being below 80%. If a borrower has not invested any of their own money into their home and there is no equity in the property, there is less incentive to struggle on with mortgage payments and borrowers are more likely to relinquish their homes in times of financial difficulty.

It has also been common practice in the US to offer low-start mortgages, where, in many cases, the payments do not even meet the interest charged and therefore place an even greater burden on borrowers once this initial period has ceased. This type of mortgage was pretty much abandoned in the UK after the problems with high levels of repossessions in the early 90's.

As previously mentioned, although interest rates in the UK have risen by 1.25% since August 2006, in the US the rate has risen from 1% in 2004 to 5.25% in 2006, further exacerbating the situation. Also, the average level of debt for every person in the US is almost four times that of the average person in Britain.

In conclusion, it would appear that we are taking a more cautious view of Sub-Prime lending in this country compared with the US. This does not mean, however, that we are out of the woods yet. Indeed far from it. Many Sub-Prime lenders are now withdrawing products, lowering loan to value levels and tightening up on their lending criteria, which has to be a good thing for the long term survival of this sector of the market. The downside for consumers is that if you are looking for a Sub-Prime mortgage in the near future, it is likely to be harder to get and it may well cost you more.