Tighter mortgage rules - what now for borrowers?

The Financial Services Authority has announced a further clampdown on mortgages which will make it harder for many people to get a loan. We take a look at what's been announced and what it will mean.

What is the FSA proposing?

On the back of an increase in the number of people defaulting on mortgage payments and accusations of irresponsible lending on the part of some banks and building societies, the FSA, the city watchdog, is tightening up mortgage rules.

Affordability

When someone applies for a mortgage, the lender will have to carry out more rigorous affordability checks to ensure it doesn't lend more than the applicant can really afford. As part of this, applications for interest-only mortgages will be assessed using the same criteria as those for a repayment mortgage.

As the name suggests, payments on an interest-only mortgage cover the interest costs only so you are not paying down any of the capital. Monthly payments are therefore lower than those on a repayment mortgage (where the monthly payments cover both the interest and some of the capital). If you opt for an interest-only mortgage you are supposed to have a separate savings vehicle set up so that you will have the money to pay off the debt at the end of the mortgage term. However, there is a fear that thousands of people have taken out interest-only mortgages because they see them as a cheaper option and have not thought about how they'll actually repay the mortgage.

As a result of the new FSA proposals lenders will have to make sure borrowers can afford the mortgage if they were to take it out on a repayment basis. Borrowers may also be asked to prove that they will be able to repay the loan when the term of the mortgage ends.

Self-certification

The new proposals from the FSA effectively ban self-certification mortgages. These were designed for people who are unable to prove their income - perhaps because they are self-employed or have an irregular salary. Instead, the applicant merely had to state their earnings and declare that the information on their mortgage application is true and accurate. However, some people abused the system and opted to 'self-cert' so that they could inflate their true earnings in order to be able to get a larger mortgage.

As a result, the FSA has said everyone applying for a mortgage will have to provide proof of earnings.

Extra protection for the vulnerable

One of the reasons why the number of people falling into difficulties with their mortgage has increased is because many over-stretched themselves and borrowed more than they could afford. The FSA said its new measures should reduce this risk going forward.

Lesley Titcomb, FSA director responsible for the mortgage market, said: "There is a clear link between financial overstretch and mortgage arrears and repossessions, and we are determined to protect vulnerable consumers by making sure everyone can afford to pay it back."

What does all this mean for borrowers?

While it is imperative that banks and building societies lend in a responsible manner, the measures announced by the FSA will make it harder for many people to get a mortgage.

It is a careful tightrope to walk because the risk is that if lenders become overly cautious, many aspiring first time buyers will be stuck, unable to get onto the property ladder.

We've already seen banks and building societies clampdown on who they will lend to. Pre-credit crunch it was easy to borrow up to 90% of a property's value and have access to the leading mortgage rates. Now, most of the leading deals are reserved for those with a deposit of 25% or more.

Over the past few months we've seen an increase in the number of lenders willing to lend to those with smaller deposits, but you'll still pay a premium on the rate for the privilege.

Lenders have also scaled back on the amount of money they'll lend, adopting more conservative affordability calculations and in order to qualify for a mortgage, you'll need a squeaky clean credit history. Therefore, in theory the affordability assessment proposals put forward by the FSA shouldn't have a huge impact.

In fact, when it comes to interest-only mortgages, banks and building societies should already be ensuring that applicants can only borrow as much as they can afford to repay, based on a repayment loan. Where many have become lax over recent years is when it comes to asking for proof that the applicant has a repayment plan in place.

Consequently, expect to see a return to the days of having to prove that you will be able to pay back the capital if you take out an interest-only mortgage. Some lenders have already changed their policy in this area.

Halifax for example, requires borrowers to provide evidence of the repayment plan they have place and it has changed what it will accept as a viable method of repayment: an inheritance; the sale of the property or business are no longer acceptable. Halifax has also launched a dual pricing structure so you'll pay a higher rate of interest if you want to take out an interest-only mortgage. It is clearly trying to discourage people from taking loans out on an interest-only basis.

Why we need to be careful that the pendulum doesn't swing too far the other way and strangle the market

Interest-only mortgages can be useful and they have a role to play. Many people have to stretch themselves in order to get onto the property ladder and having an interest only loan for the first few years can make it affordable (of course, the danger is that they 'never get round' to switching onto a repayment loan).

Also, self-certification can be a real help. While some people clearly abused the system and used self-certification as a way of borrowing more than they could really afford, the vast majority used it as it was intended: as a means to get a mortgage when they otherwise wouldn't qualify using traditional lending criteria. The principle of self-certification was also used to 'fast track' applications of lower risk borrowers ie. those with very large deposits or who were only looking to borrow small amounts.

The FSA's decision to effectively ban self-cert will therefore be seen by many as a regressive rather than progressive step.

Some lenders, and borrowers, have undoubtedly been guilty of acting irresponsibly in the past and we need to ensure that the same thing doesn't happen again in the future. But with mortgage data still depicting a weak market, there is a risk that the recovery could be hampered rather than helped by the measures announced by the FSA.