Mortgage lending takes many forms – residential house mortgages for the owner occupier or loans for the Buy to Let investor or commercial loans for small businesses.
The term ‘mortgage lending’ implies that the loans are for the long term, seldom less than 15 years and are made by building societies or demutualised societies or by specialist bank departments. Many of the mortgage lenders are centralised lenders i.e. those without a branch network.
Owner Occupier & Buy to Let Loans
Owner occupier mortgage loans are perhaps the most straightforward of the loans; the original ‘mortgage’. Buy to Let loans grew up when residential property became an attractive investment for the small investor as an alternative or supplement to a pension. Whereas owner occupiers were deemed to be reliable borrowers because they would try hard to service their loans so as to avoid losing the ‘roof over their heads’, Buy to Let loans were also attractive to the lenders. While the threat of losing a home does not work to the lender’s advantage in the case of the Buy to Let borrowers, their loans have the advantage of being secured by a property with rental income providing the wherewithal to pay interest.
The size and terms of a commercial loan (commercial mortgage) are determined by the amount of the loan in relation to value of the property to be charged and the maintainable income from the business.
In considering the different type of lenders, there has been much litigation involving centralised lenders where business is sourced from brokers unlike traditional building societies which build direct relationships with their members and borrowers. Centralised lenders’ business model relied not only on brokers but also upon packaging companies that assembled the requisite information on the borrower and the property for submission to the lender. It was almost inevitable that litigation would follow. Having said that, the centralised lenders’ business model was a very low cost one and gave the lender potentially high rewards as portfolios of loans were sold off to investors, thereby allowing the generation of more mortgage loans without the need to increase capital.
There are two financial determinants of the maximum loan that an applicant might be offered. One relates to the valuation of the security property and the percentage of value that the lender is prepared to advance – called Loan to Value (LTV).
The other financial determinant in the case of Owner Occupier loans is the number of times the loan exceeded the applicant’s income. It was a crude measure as few lenders took any account of the other outgoings of the applicant.
In the case of Buy to Let loans the earnings were not usually a determinant but the number of times that the anticipated rental income exceeded the expected interest (Rental Cover) was. Percentage cover varied from 100% (once times) to 150% depending upon the lender and product selected.
Conforming & Non-Conforming Loans
Loan products were divided into those that were ‘conforming’ and ‘non-conforming’, the latter being for those with imperfect credit history. In examining an applicant’s credit history, lenders were less concerned about missed payments on finance agreements and, on some products, County Court Judgments were tolerated. However, missed payments on mortgage loans were less welcome for fear of history repeating itself.
Mortgage lenders devised quite rigid lending policies and the applicants’ credit rating and circumstances had to fit defined criteria to qualify. There would be several levels of risk that lenders were prepared to take, depending upon the applicant’s credit rating and the LTV sought (and Rental Cover in the case of Buy to Let applicants. Each product was given a name, and each was defined in a Product Guide issued to brokers. To consider whether the lender had acted correctly, the lending expert witness has to consider both the Lending Policy and the Product Guide.
Many lenders have sophisticated web based systems so that brokers may obtain a decision in principle (DIP) prior to making a formal application on behalf of their client. In arriving at the DIP, the lender is greatly assisted by the results of a credit reference agency search. With this information and knowing the applicant’s profile, the application can be ‘credit scored’. The score would indicate whether a loan could be made and dictate the type of loan product offered, and the terms.
Some loans products were available on a ‘self-certified’ basis. This was a reference of the readiness of the lender to accept the applicant’s word as to his income whereas normally an applicant’s stated income was verified. Self-certification gave rise to several concerns, in particular the reasonableness of the claims made by the applicant.
Many loans in the past were made on an ‘interest only’ basis. In the case of Buy to Let loans this was entirely reasonable – at the end of the term the property could be sold or the loan refinanced. In the case of owner occupier loans, the danger was that the borrower would not set up a sinking fund so that the loan could be repaid at the end of the term without having to sell the property. Once upon a time, lenders were concerned to see firm evidence of a suitable investment vehicle, even taking a charge over it. Such precautions fell away some years ago and lenders simply relied on warnings to the borrower to make the necessary provisions.
When instructing the acting solicitors (usually the same as the applicant’s), lenders refer to the requirements of the Council of Mortgage Lenders’ Lenders’ Handbook, a set of standard instructions devised by the CML and the Law Society. The requirements often give rise to litigation when solicitors ignore specific matters, leading to loss.