Sub prime market growing – but under fire

According to new research, as Britons struggle to keep up with growing debts, sub-prime mortgage lenders are on the increase. These lenders offer loans to people who have been refused credit by mainstream banks or building societies. The reasons can be varied, but often it is because they have defaulted on payments in the past.

The sub-prime market increased by 28% during 2006, making it worth £24.6bn, said market analyst Datamonitor. Its research suggests that the market will continue to expand, and at a rate which is twice as fast as the regular mortgage market. This is as a result of levels of debt in Britain, which are at their highest ever level and still increasing, and a more difficult economic environment for individuals and families, with interest rates on mortgages and loans at higher levels than of late.

The sub-prime market is forecast to grow at an annual rate of about 5%, to reach a value of £31.5bn by 2011, according to the report. The authors commented that there are significant opportunities in the sub-rime mortgage market in the UK, although growth has actually started to slow recently.

The market has been growing as a result of healthy economic growth, (previously) low interest rates, low levels of unemployment and a booming housing market. With these factors in place people are more willing to borrow money so that they can join the spending boom. Now the factors are beginning to change. With economic growth under threat from rising interest rates (which are designed to pull inflation down, but will slow the economy too), with interest rates on the increase, with unemployment creeping up and with the housing market beginning to slow down, more consumers are having trouble meeting their financial commitments. The more difficult economic conditions together with the high levels of debt will help to push the sub-prime market forward in the next five years. As more people default or make late payments, more will become sub-prime mortgage candidates.

The report also said that the sub-prime market itself was running the risk of having more defaulters. Lenders were open to problems with consumers running high debts and interest rates on the increase. Lenders have been taking more risks in recent years as they became more confident in their risk models and began to offer higher multiples of income as loans.

There have been problems in the United States recently with sub-prime mortgages, leading to a crisis where high numbers of sub-prime mortgage borrowers have begun to default on their loans. The experience across the Atlantic should serve as a severe warning to UK sub-prime lenders to not over-expose themselves to undue risks. The warnings from the report and from the US suggest that in the current and foreseeable economic climate lenders should ensure that customers do not borrow more than the can afford.

The Financial Services Authority (FSA) recently made criticisms of the sub-prime mortgage sector for not properly assessing the customers’ ability to afford their home loans. None of the 11 organisations surveyed followed responsible lending policies adequately.

The subprime industry is also heading for further trouble as it may be subject to legal claims touching billions of pounds after the FSA found inadequate lending checks for loans to vulnerable borrowers.

Law firm Reynolds Porter Chamberlain of London has told lenders and brokers that they had better be prepared for a legal battle after the recent critical report from the FSA, which found a range of problems in processes of mortgage loans to sub-prime homebuyers who would struggle to make their repayments. The solicitors believe that the findings of the watchdog could lead to a number of mis-selling claims against advisers, brokers and lenders – as customers enter an even more desperate period with interest rates having gone up five times in the last year, and likely to reach 6% before the year is out. Claims, speculated the law firm, could run into the billions, with lenders and intermediaries in the sector taking big hits, with dire consequences for the sector. Business prospects are likely to be hit in the immediate future, following the FSA’s poor report. The FSA carried out spot checks and found several problems with compliance. It is taking action against five brokers, the result of which could be a fine or even a trading ban.

The sub-prime sector caters for people with poor credit histories, or those that cannot get mortgages with regular providers for other reasons, such as irregular income. The arrears in the sector are 20 times higher than those for conventional home loans. There is no likelihood of that situation improving with the financial situation getting tighter for people already in difficulty. Economic experts say there is every possibility that interest rates, already vat their highest level for 6 years, will reach 6% before year-end and some gloom merchants say it may not end there, with 6.25% a possibility in early 2008.