FOOL'S EYE VIEW
How To Avoid A Dangerous Mortgage

By Jane Mack (TMFJane)
February 10, 2004

Last autumn, the BBC's Money Programme went under cover to find out whether estate agents and mortgage brokers were encouraging homebuyers to lie about their incomes in order to borrow more money.

Judging from the results of their secret filming, it appeared to be true, and the follow-up programme on Wednesday night on BBC2 claimed that little had changed.

The city watchdog, the Financial Services Authority, disagrees. Following the first programme it launched its own investigation and published a report earlier this week saying that borrowers don't appear to have been taking on larger mortgages than their income would justify.

Its reasoning is based on the fact that people who have borrowed via a self-certification mortgage - where lenders don't require any proof of income - don't appear to be having any more difficulties with repayments than those with standard mortgages.

Self-certification mortgages account for about 6% of overall mortgage balances but they're increasingly popular. About 8% of all new lending is now through self-certification. They're aimed at the self-employed, contract workers and those on irregular incomes and enable applicants to simply declare their incomes without having to provide any accounts or pay slips to prove it.

They also come with strings attached such as higher rates and stringent redemption penalties although some will allow payment holidays if you're having cash flow difficulties and allow you to overpay when times are good.

However, when most lenders still work on income multiples of roughly three times your salary, you can see that it would be tempting to someone who doesn't earn quite enough to get the mortgage they want, to go for one where their annual income appears to be irrelevant to the lender.

Only last week the Halifax announced that the average price of a first home had broken through the £100,000 barrier. If you're earning an average salary of about £25,000, getting on to the property ladder is simply unaffordable if you don't have a big enough deposit. Unless you lie about your income and make a fraudulent mortgage application!

I was talking about this last night to a friend of mine who's a branch manager for a mortgage lender and she opined that lenders are shooting themselves in the foot by sticking to income multiples as their main lending criteria. Affordability is what counts, she said, and desperate people wouldn't have to lie to get a self-certification mortgage if lenders were more prepared to take into account what they can actually afford each month.

She cited an example: Someone earning £25,000 a year would, in usual circumstances, only be able to borrow £75,000. At a mortgage rate of, say, 4.5% it'll cost him £416 a month - just over a quarter of his monthly income. But if lenders operated on affordability (and on the basis that a third of one's monthly income is a reasonable amount to allocate towards mortgage payments), our homebuyer could afford a £100,000 mortgage with monthly payments of around £555.

Ah, I said. But what about when interest rates go up? If they doubled to 8%, you'd be spending a dangerously high 50% of your income on your mortgage, wouldn't you? Fix your mortgage rate for a few years, she said, and deal with that problem later if and when it arises.

I agree with her that using income multiples is probably rather an old-fashioned way of lending prospective homebuyers money. But, I would still say that if you are borrowing money to fund a house purchase you have to be sensible about the amount you can really afford to borrow.

According to mortgage brokers, London & Country, both the Halifax and Abbey are prepared to consider affordability and, perhaps, even offer a longer term if you can show that you're worth taking on, for example by being able to show you've got a good credit record.

Either way, don't be tempted to misuse a self-certification mortgage. And, remember, not only can interest rates go up as well as down but house prices can go down as well as up.

Find out more about Mortgages; More Mortgage Madness