Sub-prime mortgages – think twice

The fastest growing sector of home loans market is what we class as specialist mortgages. Specialist mortgages have developed to serve the mortgage needs of people who don’t fit into the more conventional model buyer. In the case of self-employed buyers, the introduction of self-certification mortgages has made things much simpler. A statement of earnings is normally all that is needed, provided the business has been up and running for couple of years. Normally, a 25% deposit is needed and interest rates will be slightly higher than usual. This is just one example of a specialist produce.

Another type of mortgage, which is causing concern to Citizens Advice Bureaux (CABs), is designed to serve the needs of people with a poor credit record. It is known as a sub-prime mortgage, or sometimes called a credit repair mortgage.

Unbelievably, there are over 4,000 different versions of this product on the market. There are variable, fixed and discount rates. The mortgages are extremely complex, higher fees tend to be charged, the amount lent compared to the value is likely to be lower and interest rates higher than in the rest of the mortgage market.

The sub-prime mortgage has varying levels. For a would-be buyer who has missed a couple of loan repayments in their past, it’s likely that a “light” or near prime version would be offered. If the same person had a poor credit rating, county court judgements against them or was a discharged bankrupt, then they would have a “heavier” or sub prime type of mortgage offered. Dependent on the results of the credit rating, there could be an interest charge of more than 3% on top of the average standard variable rate mortgage. There’s a big gap between sub-prime and near-prime. Another snag is the cost of the fee for setting up the loan. Commonly there’s a charge of 2 to 2.5% of the loan.

The concern of the CAB relates to the indication that mortgage lenders specializing in sub-prime mortgages are giving social housing tenants the encouragement to purchase their homes with mortgages that they simply cannot afford.

Right-to-buy has resulted in more than 1.6 million council and housing association tenants purchasing their homes since it was introduced in 1980. It is thought that recently the surge in the sub-prime market has meant that offers of loans are being made to riskier customers. Tenants eligible for a right-to-buy deal get a discount on the value of their property. This ranges from £16,000 to £38,000, depending on the area. The vendors of the sub-prime mortgages appear to be persuading buyers to extend their mortgages and combine current debts. This, combined with the charges and higher interest rates, quickly erodes whatever gain might have been achieved by the discount. Many of the clients who approach the CAB with mortgage arrears are in trouble directly because of this situation. They run the risk that, unable to keep up their repayments, they will become homeless and will also consequently lose their right-to-buy position.

There has been a reduction in the number of sales of right-to-buy properties in the last few years. The Housing Act of 2004 brought in some tighter rules and restrictions, together with reduced discounts, especially in areas with higher house prices and higher homelessness levels.

In September 2005, there was a report by the Financial Services Association, which voiced concern over what checks were employed to check the borrower’s suitability for these mortgages and questioned the advice given by some brokers. A further investigation to this is planned.

Incidentally, first time buyers with no credit record will struggle to get conventional mortgages with competitive interest rates. A history of debt, repaid promptly, will stand you in much better stead when the time comes for a mortgage, than no debt at all!