Mortgages & housing

Why self-cert is no dead cert

May 2007

The last 12 years have been remarkable for so many aspects of the UK property market: soaring prices, soaring home loans and booming transactional business for everyone linked to this incredible market.

One niche, however, that has done exceptionally well for lenders and advisers in particular is self-certification.

Paul Marsh, an analyst at the research company Datamonitor, says: “The market grew by between 25 and 30 per cent in 2006, and by 20 per cent in each of the previous five years; 2006 was a record year for the mortgage market generally, so it is no surprise that self-cert did well, but its rate of growth was slightly higher than the overall market.”

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No universal agreement

Judging by anecdotal evidence from brokers and lenders alike, self-cert certainly has experienced stellar growth since the market really got going around 15 years ago. However, hard and fast numbers are difficult to come by because, say lenders, no organisation is known to have systemically tracked the sector's progress consistently or comprehensively, nor has a universal agreement of the definition of self-cert been hammered out.

Marsh says: “Self-cert has grown dramatically from 10 years ago, and we estimate that it now accounts for around 5 per cent of the whole market and is gradually getting bigger.” He cites the proliferation of self-employed workers and other new working patterns. “More and more people have more than one job or have variable work activities or income streams rather than just doing the standard nine-to-five job.”

Andy Wiggans, director of mortgage products at Bradford & Bingley, observes: “Self-cert is a real growth area. For Mortgage Express, our specialist lending arm, buy-to-let is what we do the most, but its second-biggest slice of business is now self-cert.”

Darren Cook, a market observer at Moneyfacts, says: “Thirty-five lenders now offer these types of products. For every 100 mortgage products available on the market, 17 of them are self-certification. Typically the maximum loan size is £500,000 and the average loan-to-value (LTV) limit is between 80 and 85 per cent.”

But Wiggans notes that there is no industry-wide cooperation in tracking the sector's size or in agreeing on what the product really is: “We have had conversations with the Council of Mortgage Lenders (CML) about this. We would like to see lenders sharing data about how much of this business they are writing and agreeing a universal definition. We raised the issue in mid-2006 but nothing has kicked in a result of those talks. Everyone is interested to know how the market is doing. The CML publishes data on other markets but not on this one.”

Bernard Clarke, spokesman for the CML, concurs: “We don't collect specific data to quantify the self-cert market.” Meanwhile, Julie Gaskin, corporate relations manager at GMAC-RFC, has a bigger market measure: “Our board thinks that the Datamonitor estimate looks low and that self-cert now accounts for 20 per cent of the overall market, and we exclude Fast Track business from this estimate.”

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Self-cert versus fast track

A source of confusion among various lenders is the definition of what a self-cert product really is. “People tend to talk about self-cert as being a mortgage where people don't have to prove their income,” says Wiggans. “But sometimes it gets confused with fast track, where the lender may only check one in ten applications for proof of income. This checking is often done randomly in that way. That's how things worked at HBoS, for example, where I used to work.”

He adds: “But fast track is not really self-cert. I am quite clear about this: if you reserve the right as a lender to ask for proof of income, then clearly your product is not a self-cert product.”

Cook agrees. “Abbey, for example, was marketing some products as self-cert but still checked one deal in four for income proof, which isn't true self-cert. So we took them out of our self-cert tables. They weren't necessarily wrong to do what they were doing, as there was no firm definition of what self-cert was, but they now call that set of products 'fast track' instead.”

Cook notes that fast track is intended as a way for lenders to speed up transactions with customers who appear to be a low credit risk, perhaps because they are taking out a mortgage with a low LTV ratio and have a previous relationship with the lender: “Often, if you have a bank account with the lender in question, the lender can make a decision based on your existing relationship. They may already know your accounts information and therefore don't need to see your payslips. But fast track is not for first-time buyers, for example.”

Marsh agrees: “Mainstream lenders do fast track for people who have quite low LTVs and who are not first-time buyers. These are customers who appear very creditworthy at first glance and don't need their credentials checked. In these types of scenarios, lenders may use automated valuation models for the property particulars. There is an overlap between fast track and self-cert, however. Fast track lenders can go back and verify income. But with self-cert, lenders must draw a line at some point and cannot then go back and ask for proof of income.”

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Surprising progress

Despite the nitpicking about how the market is defined and measured, most players in the sector might feel compelled to agree that its success in recent years has been a very welcome development, particularly given the adverse publicity a few years ago.

In 2004, the BBC broadcast evidence on television that some brokers were encouraging their customers to lie about their income to obtain mortgages. Furthermore, research and a 'mystery shopping' exercise by the Financial Services Authority in 2005, focusing on small firms, concluded that “sales and advice from brokers show significant weaknesses which are disappointing”.

The FSA added: “Further work needs to be done not only on affordability and suitability checks but also on the record-keeping of the advice given. But it is encouraging that we have found no evidence to suggest that salary inflation is widespread or systematic within the broker industry.”

The regulator also published a summary highlighting examples of good and poor practice to help intermediaries to understand and meet the FSA's requirements.

The CML's Bernard Clarke said that abuse of the self-cert market “wasn't as widespread as [the media] implied”: “Where is the evidence of [widespread] mis-selling? There has been no significant rise in payment problems or abuse. There is no evidence of systematic failure and we haven't put forward to the FSA a case for tighter regulation.”

He added: “There have been fraudulent applications but they have been very small in number and it is the smaller intermediary firms that have been in need of making improvements in these areas. We are not particularly concerned about self-cert.”

Others agree. “The perception is that the fraudulent element has been pretty much driven out of the market in terms of brokers encouraging customers to falsify income,” says Marsh. “Our research shows that intermediaries are more concerned that customers are more aware about self-cert and are doing the lying themselves. Customers can sometimes say whatever they want and get away with it. But underwriting is becoming more sophisticated and lenders are picking out fraudulent applications.”

Cook, meanwhile, pointed out the dangers of the FSA getting too involved in the market. “Regulating self-cert more tightly would possibly kill it off,” he said.

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Premium pricing remains

Despite the proliferation of self-cert lenders and products, these types of products still come at a price. “People do pay a premium, generally, for them,” says Marsh, “although there are always anomalies.” Cook reckons that the premium is usually “around 15 or 20 basis points, although it depends on the lender's attitude to risk”.

As an example, Julie Gaskin of GMAC notes that for her firm's two-year fixed-rate deal at 5.89 per cent, with proof of income, the premium for a self-cert is an additional 20 basis points for loans of up to 85 per cent LTV, taking the pay rate to 6.19 per cent.

“But for bigger LTVs of up to 90 per cent the pay rate rises to 6.29 per cent,” she says. There is also a £795 arrangement fee for these deals on completion, plus early repayment charges of 4 per cent in the first year, and 3 per cent in the second year, “with one month's notice in lieu of interest thereafter”.

Another lender says: “The higher rates for self-cert deals reflect the fact that we know less about the customer. The higher price, which for us is typically around 25 basis points, reflects the higher risk.”

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Market prospects

While pricing premiums persist for these types of deals, so too does the list of key players in the sector. “The dominant ones are BM Solutions, GMAC, Bristol & West and Mortgage Express,” says Marsh. “There are relatively few players and they are attached to larger firms on the whole and have their structures and intermediary links in place. Although new entrants like edeus, with its heavy emphasis on using the latest technology, have come into the market in the last year or so, there is definitely room for new players.”

Gaskin agrees. “There is always room for new players,” she says. “More competition is good for consumers.” But Marsh sounds a note of caution: “New players may find it hard to come in from scratch. Also, the market is growing but may not grow so fast in the future. We expect its growth rate to moderate slightly in 2007, although the rate will remain ahead of the overall mortgage market this year.”

Marsh declined to make forecasts for the years ahead but others expressed their confidence. “We are bullish about the main mortgage market and slightly more bullish about self-cert,” says Wiggans. “We are believers. Interest rates are low and the more we know about this sector, the less risky it gets. Demographics will push it up further. But it has had its steep curve of growth. It is becoming mainstream now and is not special any more.”

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Blurring lines of distinction

Such comments resonate elsewhere. Surprisingly, however, Gaskin points out that, despite Marsh's and Wiggans's assessments that the market is rising sharply, GMAC's self-cert book is actually falling in size. “Our sales of these types of product are in decline. This is because lots of people can now have our mainstream products instead now that we have widened our criteria to accept 100 per cent of most income sources. We accept bonuses and commissions, second jobs of six months or more and certain types of benefits. Previously we wouldn't have accepted these types of income.”

She argues that by changing its underwriting criteria in this way, GMAC has enhanced the way in which it treats customers fairly. “It means our customers get a lower interest rate,” she says, while acknowledging that “lots of other lenders, such as UCB Home loans and BM Solutions, have gone down that route.”

Wiggans agrees with Gaskin up to a point. He notes that lenders are taking a wider range of incomes into account with their mainstream underwriting. “But the encroachment of mainstream business on to self-cert is not that significant,” he says. “We should know because we buy a lot of business from GMAC, for example, and there is no lack of self-cert business coming through from them. A lot of it is coming through from brokers who see it as their job to solve problems for customers.”

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Warnings about future prospects

The self-cert market, meanwhile, faces various new threats that may undermine its progress. Marsh believes that its future success depends on the overall state of the housing market.

He says: “Things are pretty easy when house prices are rising because they lower the LTVs of these deals and mitigate a lender's risk. But all that could change if the housing market stalls or suffers a correction.

“Lenders should be concerned about arrears and repossessions, even though they don't particularly want to talk about these things. Self-cert business carries a higher risk, and I imagine that it carriers higher repossession rates, although the lenders generally won't tell us and the CML doesn't collate such figures.”

As a result, he expects some lenders to tighten their underwriting criteria for self-cert products at the first sign of the housing market slowing down by, for example, lowering their maximum LTV limits.

But lenders don't agree. “There is no reason to change our LTVs because of the market slowing. The only reason to lower them would be because of the risk element in terms of arrears,” says GMAC's Gaskin. Others also disagree with Marsh. “If lenders were to tighten their underwriting criteria because of a falling market, it wouldn't just be for self-cert business. They would tighten across the board,” says Wiggans.

[BIO - ITALS]

William Comet is a freelance journalist. williamcomet@hotmail.com.

Tel: +44 (0) 7956 110465.