Self-certification lending has been courting controversy ever since it first appeared in the UK mortgage market way back in the 1980’s. As a lending facility it has always been viewed with suspicion by traditionalists and has been recently treated with outright hostility by consumer groups and the media.
Despite travelling along a bumpy road, self-cert has none-the-less endured its tempestuous journey and has helped many thousands of borrowers own a property of their own, when traditional mortgage facilities have let them down. But with the onset of regulation and the introduction of new underwriting techniques such as affordability calculations, the big question on many people’s lips is: has self-cert had its day?
Writing on the wall?
Some people are speculating that, following two hard-hitting BBC Money Programme investigations and a Financial Services Authority (FSA) mystery shopping exercise, the writing may well be on the wall for self-cert. They argue that self-cert no longer has a valid role to play in a regulated market and will be slowly edged out by more accommodating lending products and new underwriting techniques such as affordability calculations.
I don’t agree with this view. Self-cert has certainly had to weather a fair few storms over recent years, but the fact that it has come through these testing times proves it is a product that has a valuable role to play and, in my opinion, will continue to do for some time to come. I have been involved in self-cert lending for longer than most – since its inception in the 1980’s – and I know from first-hand experience that, with responsible lending, the credit quality is excellent and I have known situations where arrears statistics on self-cert have been better than on comparable prime books.
Although self-cert is often described as a ‘product’, in truth it isn’t. Self-cert is simply a facility which is made available on a number of products ranging from prime loans to non-conforming deals. As its name implies, the facility enables borrowers to certify their income themselves – they are not usually required to provide documentary proof of income to the lender.
Less than straightforward
Self-cert is particularly useful for the self-employed for whom proving income can often be a less than straightforward exercise. Most self-employed business people want to use every legitimate means possible to minimise their level of declared income in order to minimise their tax liability. Accountants throughout the country have, over the years, developed a number of ‘creative’ (but nonetheless legal) ways to do just that. For example, many business owners these days have elected to draw only a minimum salary and be paid bonuses in the form of dividend payments. This reduces their tax liability significantly, but can cause problems when it comes to declaring income for the purposes of obtaining a mortgage.
To complicate matters still further, the self-employed often have income patterns that are far from regular. Businesses can be seasonal in nature and people can also generate income from more than one source, including portfolios of investments. Proving income can not only be difficult, but sometimes be downright impossible.
It is not only the self-employed who can encounter such problems. In certain circumstances, employed individuals who are on PAYE can also find defining or proving income difficult. For example, bonus payments can constitute a large portion of a person’s income and individuals can also have more than one source of income and income derived from investments. Self-certification is therefore not purely the preserve of the self-employed; it can also be a useful facility for employees.
Unpopular roots
Self-cert first appeared in the UK mortgage market in the 1980’s, although it wasn’t called self-cert at the time, and The Mortgage Business (TMB), which I set up and ran from 1989 to 1997, was very much one of the leading self-cert lenders throughout that era. In the early 1990’s self-cert, both as a name and a facility, was disliked by many traditionalists and for a time the phrase ‘high equity’ was used instead. However, this caused great confusion, particularly among intermediaries, and the name self-cert was adopted once again and has remained in place ever since.
Self-cert came under the microscope for the first time as a result of a BBC Money Programme investigation in October 2003. The programme revealed that some intermediaries and lender staff had been encouraging borrowers to falsely inflate their incomes and then use self-cert as a way to obtain larger mortgages than they would otherwise be able to get using traditional income multiples. As a result, the regulator carried out an investigation into self-cert lending and gave it a clean bill of health, saying that it could find no evidence of systematic fraud.
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The next major test for this product was the introduction of regulation. Following a period of voluntary regulation, brokers’ selling techniques were subject to tight rules and regulations and advice had to be carefully documented and, if needs be, justified at a later date. It was almost inevitable, given such a major overhaul of business practices, that some non-compliant procedures would be unearthed and that is precisely what happened when the FSA carried out a mystery shopping exercise in November 2005.
The FSA’s mystery shopping exercise involved 41 brokers and found three firms that were willing to discuss the possibility of overstating incomes with borrowers. The FSA also visited 39 small firms and reviewed 249 customer files and found strong evidence of poor record-keeping and significant failings relating to affordability and suitability checks being carried out by brokers. For example, where proof of income was available advisers failed to record why a self-cert mortgage had been recommended rather than a cheaper full-status mortgage. The FSA also found inadequate documentation supporting why specific product recommendations had been given, taking into account the stated needs and preferences of the borrower.
Clive Briault, FSA managing director of retail markets, said at the time, “The findings on sales and advice from brokers show significant weaknesses, which are disappointing. 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 systemic within the broker industry.”
Speculation
It was not just brokers who were put under the microscope by the FSA; lenders were also subject to visits. Fortunately, lenders had tighter procedures and the FSA was generally happy with the practices being adopted by them.
The results of the FSA thematic work and mystery shopping exercise fuelled speculation that the FSA was not at all keen on self-cert, particularly self-cert for employed borrowers, and was eager to bring self-cert lending to a halt. However, there is no evidence to support this speculation. On the contrary, the FSA appears to have taken a very pragmatic approach and has made it very clear throughout its investigations that what it is primarily concerned about is seeing evidence of best practice.
Intermediaries therefore need to ensure that their record-keeping and documentation is in good order. If they have recommended self-certification (or any other type of mortgage product for that matter) they need to be able to show documentary evidence of the reason why they have made a specific recommendation.
Assessing affordability
A core part of the advice process is the need to assess affordability. Even though a borrower may be applying for a self-cert mortgage, it is still the responsibility of the broker to ensure their client can afford to repay their monthly repayments. That means checking income and outgoings and ensuring that the information given by the client seems reasonable. For example, the average salary for a builder’s labourer is £16,700. A client stating a salary of £30,000 should immediately raise suspicion – it certainly would to a lender. If you are unsure what level of salary is reasonable, websites such as www.payfinder.co.uk are extremely helpful and give national average salaries for almost every job in the UK.
Affordability has become increasingly important in a regulated mortgage market and an increasing number of lenders have now adopted affordability calculations as the basis for assessing maximum loan amounts, rather than traditional income multiples. Affordability calculations are far better at assessing a person’s real ability to repay their mortgage, because they are based on net disposable income, rather than simply gross income. After all, it stands to reason that a borrower who is unencumbered by high levels of debt and monthly living expenses, can afford to borrow significantly more on a mortgage than someone on a similar gross salary, but who is carrying a high level of debt and who lives an expensive lifestyle.
A diminishing need?
As affordability calculations have been introduced by an increasing number of lenders, so the need for self-certification has started to diminish. Cases that would have been pushed down the self-cert route in the past are now switched into products which are based on affordability models. At the same time, lenders have been reviewing their lending criteria and today many standard products will accommodate applications which would have been classified as self-cert in the past.
This does not mean, however, that it is the end of the road for self-cert. The fundamental reasons for borrowers requiring self-cert have not changed and are just as valid today as they were back in the 1980’s. Self-cert fulfils an important role and will continue to do so for the foreseeable future.
Accurately determining the size of the self-cert market is difficult because Council of Mortgage Lender (CML) statistics do not identify self-cert as a product in its own right. However, lenders who are active in this market tend to agree that the market is worth between £22 billion and £25 billion in gross lending each year. (This figure does not include what has been termed ‘fast-track’ lending, i.e. low loan-to-value (LTV) mortgages where income does not need to be proven).
The range of products offering self-certification is enormous and brokers and their clients are certainly not short of choice. Many lenders will offer self-cert up to 90 per cent LTV and gone are the days of high premium rates. The margin over full status mortgages is now very small.
Self-certification is a facility which brokers can use, in appropriate circumstances, to add real value to the service they provide for their clients. Many borrowers are not aware of self-certification and it can provide an instant solution to the age-old problem of trying to prove income in the traditional way.
The future for self-cert appears to depend not on demand for the product – which seems to remain high – but on intermediaries and lenders adopting best practice and selling the product in a responsible way. Most importantly, brokers need to keep on top of their record-keeping and ensure that, if ever they are asked to ‘prove it’ by the FSA, they are able to do so.
