The MMR's 3 key underwriting principles

The MMR's 3 key underwriting principles



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With the FSA outlining three principles at the core of the latest MMR consultation paper (CP11/31) for good mortgage underwriting, B&C wanted to find out what some within the industry think of these principles and their proposals.

Underwriting is the backbone to any lending organisation and the value of proficient and quality underwriting cannot be overstated enough. The FSA is focusing on good underwriting in an effort to prevent a return of risky lending.

The FSA has raised concerns over the quality of lender underwriting practices, both at the time the loan is advanced and, where applicable, where the loan is extended.

At the core of the FSA proposals are three key principles of good mortgage underwriting:

     (1) Mortgages and loans should only be advanced where there is a reasonable expectation that the customer can repay without relying on uncertain future house price rises.

     (2) Lenders should assess affordability, which should allow for the possibility that interest rates might rise in future: borrowers should not enter contracts which are only affordable on the assumption that low initial interest rates will last forever; and

     (3) Interest-only mortgages should be assessed on a repayment basis unless there is a believable strategy for repaying out of capital resources that does not rely on the assumption that house prices will rise.

The FSA does acknowledge that, in its view, almost all lenders are applying these principles and lending prudently in the current economic climate but that it is concerned, however, that “as money returns to the market, firms will come under increasing pressure to consider riskier lending and will focus more on market share than maintaining lending standards.”

Helen Farmer, Head of Underwriting at Tiuta, sees the MMR proposals being the FSA’s way to prevent the return of risky mortgage lending. Helen said: “As a bridging lender, these proposals will be viewed differently to a long-term lender although ultimately we will need to be aware of how individual lenders apply these principles to their criteria.”

In respect to the three principles, outlined above, Helen believes: “They are common-sense principles. If a customer cannot repay the loan at the end of the term, or service the monthly payments in the event of an interest rate rise, then we should not be lending. It is impossible to predict how rates will change - I remember mortgage rates of 17 per cent, although a return to this level is unlikely.

“However, these principles are open to the interpretation of individual lenders and if taken to the extreme, then this will have an effect on the number of customers obtaining the mortgages they require and therefore affecting the property market further. How exactly do you quantify ‘reasonable expectation’? There have been a number of instances of people who have taken out interest-only mortgages relying on rising house prices and now find themselves in a negative equity position. This is not only a problem short-term, but may well be a long- term issue as well. These principles can only serve to protect the customer, as well as the lender.”

B&C also sourced a broker’s perspective on the FSA’s three principles and lenders’ criteria. Ben Gardner, Managing Director at Gardner Finance Ltd, said: “Lenders have to be more understanding when it comes to the self-employed…An affordability assessment is usually always carried out already along with stress-testing for rate rises, but it is sometimes too prescriptive – a first time buyer can only make a guess of their monthly outgoings.”

He added: “I don’t have a problem with a lender insisting on a client having disposable income and to factor in inflationary costs of insurance, utilities etc., but if a next time buyer or re-mortgagor has demonstrated they have been able to pay £1000 per month (whether on an existing mortgage or even rent), proven by bank statements, over a period of time without financial distress then they should consider the new mortgage or loan, especially if it makes the monthly payment lower. Rather than stick to a set income multiple or affordability calculation more common sense should prevail. The FSA or any lender cannot dictate who can survive on what amount of money – some people like to eat out 5 times a week, others live on very little.”

Ben believes that interest-only mortgage should not be assessed on a repayment basis, stating: “If they are paying into a pension, isa or other savings then this should be taken into account in the affordability.

Ben thinks the effects of the MMR proposals have, “already had an effect with lenders toughening up on interest only lending and affordability calculators. They jumped when this was just a discussion paper.”

Highlighting the effects there may be Helen added: “Lenders will have to tighten their criteria, which will lead to less flexibility being applied by individual underwriters who have to comply with company policy.”

James Bloom, Chief Executive at Regentsmead, said: “I believe these are all fundamental principles which should have been in force years ago and if they had we may well not have had the sub-prime crisis we have had.”

The FSA anticipate that the new rules will only have a “marginal effect” in the current market conditions, but would act as a significant constraint if lenders were in danger of returning to certain reckless practices.

The main aim of the MMR is to ensure the continued provision of mortgage credit for the great majority of borrowers who can afford it, while preventing the re-emergence of the tail poor lending practice which led to customer detriment.

In the FSA’s Business Plan 2011/12 Hector Sants, Chief Executive Officer at the FSA, stated: “We want to replace the risky lending and unaffordable borrowing of the past, with practices and rules that work. We also want to ensure that lenders are acting responsibly and that consumers do not take on mortgages they cannot afford.”

The FSA believe that these are common sense principles of good underwriting which serve the interests of both lenders and borrowers. They do, as mentioned earlier, believe that almost all lenders are currently applying these principles; the excesses of the pre-crisis period have largely disappeared from the current market, but feel that it is important to ensure that better practice endures in future when memories of the crisis recede and the dangers of poor practice return. They are therefore consulting on making these principles FSA rules; in addition, the Consultation Paper brings together several other proposals to reform the mortgage market.

The FSA has called on the industry to provide feedback on its proposals and are open to consultation until 30 March 2012.

By Jason McGee-Abe

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