A secure alternative
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New secured personal lending is forecast to hit £6.3bn in 2010, according to Datamonitor, proving that sec-ured loans are a burgeoning market.
And everyone wants a slice of the action, as witnessed by the successful launch of Mortgage Strategy's sister publication Loan Distributor and the Secured Lending Summit in Jerez. Meanwhile, Advantage has launched a specialist secured loans arm, branded ADV2.
So what is fuelling this growth and how realistic is Datamonitor's prediction for the market's growth, given the effect regulation will have when it is introduced next year?
First, let's look at what secured loans are and how they work. In short, they are loans that require borrowers to provide lenders with some form of security, usually in the form of a borrower's home.
Loans secured against a property that is already mortgaged are known as second charge loans while loans sec-ured against a property owned outright and with no existing mortgage are known as first charges.
The second charge market comp-rises lenders, introducers and brokers but unlike the mortgage industry, no packagers are involved.
Introducers are typically brokers who do not offer advice on secured loans and refer secured loan enquiries they receive to specialist brokers.
Specialists who get all their leads via third party referrals are known as master brokers.
The second charge market has been operating in the UK since the 1970s, with First National and Cedar Holdings being the big lenders. In the 1980s more lenders, including Prestige Finance and J&J Finance, joined the market.
But despite its maturity, the sec-ured loans sector has taken time to come to maturity, in part because it is seen as a last resort for debt-laden consumers requiring further credit.
This image is slowly changing, with many borrowers now likely to consider secured loans to consolidate debt or fund a one-off life event such as a wedding. So what's fuelled the change?
Robert Sinclair, director of the Ass-ociation of Mortgage Brokers, says the growth of the sub-prime mortgage market has had a positive effect on the second charge market.
"Historically, second charge mortgages have had a poor reputation as brokers have thought of them as expensive," he says.
"Before fixed rates came in, lenders only offered SVRs without exit fees and additional costs, so second charge mortgages looked expensive. Interest rates were high so secured loans didn't seem to be a good option.
"But because of the way the sub-prime mortgage industry has evolved, second charges are becoming more attractive," he adds.
In turn, the profile of typical second charge borrowers has changed, moving away from desperate payment defaulters to savvy borrowers who, with equ-ity in their properties, are looking for the most cost-effective way to manage their finances. This is no longer necessarily a remortgage.
For example, take a borrower with a £200,000 mortgage on a prime fixed rate who loses his job and falls into fin-ancial difficulty, picking up some ad-verse credit as a result.
If he remortgaged he would be for-ced to take a sub-prime deal. But by taking out a secured loan he could keep his prime mortgage deal, although the trade-off would be that the secured loan might have a high rate.
But using secured loans as an alternative to remortgaging may be a trend that will take some time to catch on, particularly if, as Andy Pratt, chief op-erating officer at Alexander Hall, suggests, brokers opt for the easier and potentially more lucrative option of remortgaging their clients.
"Some unscrupulous brokers will recommend remortgaging as it provides better commission," says Hall.
Secured loan rates are the most contentious issue in the second charge industry and one of the contributing factors behind mortgage brokers' aversion to this sector. But this is also changing.
"Five years ago rates were enormous," says Pratt. "We're talking huge, credit card-type rates. Now, they have stabilised and are somewhere between 7% and 10%."
Of course, loan rates differ between borrowers, depending on their credit rating. A borrower with no arrears or County Court judgements and plenty of equity in their house could get a deal from Paragon Mortgages at a rate of around 6.6%. This would be for a loan of between £50,000 and £150,000.
Compare this with a loan from Swift and Blemain, a secured loan specialist offering non-status products that allow any level of arrears and CCJs.
Its Any-Any product has an APR of 11.1% before additional charges such as arrangement fees.
But there has been downward pressure on secured lending rates as market competition has increased.
"What we've seen in the secured loans market is similar to what has happened in the first charge market in the past few years," says a spokesman for Kensington Mortgages.
"More lenders are entering the market and this is raising standards and driving down costs. This has caused a rise in demand from borrowers which has seen the secured loans sector in-crease in size."
But the secured loans market still has a long way to go in terms of raising standards - a situation which Simon Stern, director of Prestige, attributes to the cowboys operating in the industry in its early days.
Tim Wheeldon, managing director of Loanmakers and a board member of the Finance Industry Standards Association, says FISA aims to clean up the industry bu advising brokers and lenders on how to operate.
"In the late 1980s, lenders had it written into conditional agreements that they could put their rates up whenever they chose," he says. "So a borrower could take a good rate and then their lender could put it up whenever it felt like it."
He adds that in sub-prime lending, rates were determined by brokers' commission, which brokers themselves were able to dictate - the higher the commission, the higher the rate for borrowers.
"FISA has done a lot to tidy up the industry," says Wheeldon. "Our code of conduct advises brokers and lenders about the appropriate way to conduct themselves."
But this evolution has suffered a setback. The Office of Fair Trading re-ceived a super-complaint from Citizens Advice Bureau concerning mis-selling of single premium payment protection insurance, which led to it announcing its intention to conduct an in-depth in-vestigation of PPI sales.
Single premium products are often recommended to secured loan borrowers. Sinclair says this is necessary, given the financial predicaments many second charge borrowers find themselves in.
"Because of the nature of the borrowers involved - usually in the higher risk category - the industry needs to protect them in case they find they can't keep up their loan repayments," he says.
But PPI products have high proc fees, which is what fuelled CAB's complaint. The complaint alleges that brokers recommend these products because of the commission they can earn, not based on clients' needs.
"Based on evidence from 270 CAB offices around the country, it seems it is more about providing an additional source of profit for the financial industry than about protecting customers," states the complaint.
The secured loans industry has been deemed guilty by association, although Wheeldon says it is not to blame, with high street banks being the biggest offenders.
"The PPI issue is a much bigger problem in high street banks," he says. "For example, out of one bank's net profit, 20% was derived from PPI. I have also heard horror stories from staff working in high street banks who say they are being forced to push PPI on consumers.
"The problem for banks is they are loss lending. When you're paying a savings rate of around 4% for money and then lending it out at 5.75%, you cannot make a decent profit. Lenders make their profit on PPI."
That said, Wheeldon claims PPI mis-selling is not as widespread as the market has been led to believe.
"The Financial Services Authority doesn't like PPI," he says. "I don't think there's anything to worry about - it's not an issue of mis-selling, rather that in some cases the cover provided by companies does not match the price charged for it.
"If the FSA decides to take action against PPI lenders, rates will invariably go up. They have to make a profit somehow and this will hit borrowers."
The onset of tighter regulation next April is expected to address allegations of mis-selling and improve the overall reputation of the secured loans market.
The market is not regulated by the FSA at the moment. But loans of up to £25,000 are covered by the Consumer Credit Act, which means prospective borrowers are entitled to a 16-day consideration period, allowing them to cancel loans if they decide they no lon-ger want to proceed.
So borrowers with loans exceeding £25,000 currently have no protection, but this is set to change next April when the CCA will be extended to cover all secured loans, regardless of size.
But while this change will immediately benefit borrowers who are unsure of whether a secured loan would be the best option for them, there is concern that regulation will have an adverse affect on borrowers who are certain about their choice.
The implementation of a 16-day consideration period for all loans means that the processing time for secured loans will increase. At the same time, early repayment charges for loans over £25,000 will have to be reduced from their current high.
"This will level out the market," says Sinclair.
But he warns that the trade-off is that lenders' margins will be squeezed which means loan rates may increase. Wheeldon agrees.
"Lenders generally treat loans of over £25,000 as if they are regulated anyway," says Wheeldon.
"In 2008, when the CCA covers all loans, it will mean the processing of loans will be slower, thereby penalising clients. Also, with lower ERCs, lenders will have to rethink their structures and look at net returns so rates will go up."
But Sinclair says tighter regulation will not necessarily have a negative impact on the secured loans sector, depending on how industry players manage the transition.
So what does this mean for brokers who don't offer clients secured loans?
Regardless of the uncertainty surrounding impending regulation, brokers who do not yet offer secured loans will have to consider doing so or risk breaching Treating Customers Fairly principles.
"Brokers have a duty to offer best advice and consider all options," says Kensington's spokesman. "If they do not consider secured loans, they may not be offering best advice."
And the secured loans sector also offers brokers an efficient additional source of income.
"The processing time for secured loans is shorter than for mortgages, which means brokers can be paid quicker," the spokesman adds.
Wheeldon says a way in for brokers who are new to the secured loans market could be for them to take the introducer route. This would involve little work.
"On a £30,000 loan, a broker will typically earn between £1,000 and £1,500," he says.
"For that, they will do little work and incur no cost. They are paid for referring clients to a secured loan broker or master broker."
Whatever method of entry mortgage brokers use, they have little choice but to get up-to-speed with a market for which growth looks set to be strong for some time.
Brokers have much to gain by adding secured loans to their portfolios
Adam Henry is director of secured lending at Money Partners
In a recent report, Datamonitor pinpointed 2003 as the high water mark for secured loans when new lending totalled £7bn. Since then, the market is said to have contracted but is likely to recover to reach £6.3bn by 2010. Of that, £3.3bn will be non-standard lending.
Datamonitor adds that brokers will continue to dominate distribution and concludes that the sector offers significant growth opportunities. But what factors lie behind this?
First, there is demand. While indebtedness among Britons is high - currently £1.3trillion - so is the stock of mortgage-free equity. This is worth £3.6trillion and represents a vast reservoir of untapped security. As consumers increasingly look to unlock equity to reduce expensive unsecured debt, the potential is clear.
Secured loans offer a borrowing alternative. They particularly appeal to borrowers keen to avoid penalties as a result of remortgaging or who, by doing so, would lose the benefit of favourable fixed or discounted rates. With over half of all mortgages on such terms, this represents a sizeable market.
They are also suitable for customers excluded from further mainstream borrowing because of recent credit difficulties - a potential client pool that is increasing in line with indebtedness.
Also, many firms have seen that making the transition to secured loans is not difficult. The process is similar to that for mortgages, repayment terms are flexible and interest rates are increasingly competitive. They can also be completed faster than remortgages.
But critical to success in the future will be the sector's image. This will continue to be brought into focus as regulatory changes, particularly to the Consumer Credit Act, take effect.
Dating from 1974, the CCA is the sector's primary regulatory instrument. It has been amended frequently, but most substantially by the changes introduced in 2006. These provisions come into force next year.
The key provision is the removal of the £25,000 loan threshold. This will happen in April 2008 and cause all but a handful of exempted loans to be captured by regulation. Also included is a provision that gives courts more discretion over the enforceability of loan agreements, while another introduces an 'unfair relationship' test, which could cause problems.
Despite this, there is strong support for full regulation of the sector. It is argued this will unify secured loans lending under a single regime with commensurate benefits for firms and consumers. But whether this is likely is unclear, and may yet be determined by European regulatory proposals due out soon.
A spin-off benefit has been brought about by the entry of firms more usually associated with mortgages. Accustomed to regulation, they have been quick to add responsible lending and Treating Customers Fairly practices to their secured loans processes.
At trade body level, a positive step has been taken through the launch of the Association of Finance Brokers. Operating in alliance with the Association of Mortgage Intermediaries, it aims to benefit brokers by raising their profile while providing opportunities to influence the direction of the sector.
While secured loans offer many advantages, new entrants should understand that it is a different market from mortgages. They should also note that regulatory change will reduce their income opportunities while adding to their workload. They therefore have much to gain by linking with master brokers - established firms with good contacts.
Secured loans have a good future. While not suitable in every case, they offer an alternative form of borrowing. As the sector matures, firms that take a responsible, realistic and long-term view have much to gain by adding this important option to their product portfolios.
Good secured loans specialists will protect referring brokers' interests
Alastair Cook is general manager for business development at Click
There have recently been many discussions about the value secured loans can add to the function of mortgage brokers.
The principal opportunity arises when clients express an interest in raising funds. While the first recourse for brokers has historically been a remortgage, this has not always been possible for the following reasons:
- The client is tied into a current mortgage contract.
- The mortgage is already a high percentage of the property valuation.
- The mortgage holder has acquired a poor credit rating.
- The term of the loan required is less than the mortgage term.
If remortgaging is not an option, turning enquiries into secured loan applications can resolve clients' problems with raising funds and provide brokers with an additional income stream.
Unless brokers are fortunate enough to have access to a good range of loan providers, the most convenient solution when it comes to handling such enquiries is to call on the support of specialist brokers.
In this sector, the choice of the right loan seldom depends on which lender has the cheapest interest rate. Quote calculations are based on complex information derived from clients' circumstances. Not only does this require diligence in conducting basic fact-finds but also the ability to communicate what customers need to know to make informed decisions.
Good specialist brokers will have configured their entire operations to scan and identify appropriate lending solutions matched to individual customers' needs. The best will blend computer technology with personal contact to help them.
Passing clients on to a third party can be a daunting prospect. Client relationships are hard to come by and trust in the sales process is essential if integrity is to remain intact. Good secured loan specialists will understand this and protect brokers' interests at all times.
Brokers referring clients should expect to have access to an account manager with whom they will be able to discuss their application's progress. This will ensure their involvement, keeping them as part of clients' funding solutions. After all, the business is still based on their recommendations.
In addition to account management, brokers should look for access to secured loans brokers' systems that will provide automatic updates on the status of each introduced application. Once again, this is an essential tool in ensuring that brokers remain in control of client relationships.
When using secured loans as a solution to clients' needs, brokers can gain distinct benefits. As well as the payment of commission, a good secured loans broker will take away many of the costs incurred by introducing brokers.
They will conduct all the processing and administration of loan applications, cover the cost of valuations and surveys and in most cases not pass on the broker charges levied by lenders.
It is vital to choose the right secured loans broker. Brokers should scrutinise what provisions specialist brokers have made to ensure that while the amount of conversions from applications to loans advanced are maximised, the process remains compliant.
The continued growth of the secured loans industry implies that the number of customers taking advantage of secured loans is on the up. If some mortgage brokers have not yet looked at incorporating this opportunity into their business models, today is a good day to start.
Remember, a good broker will work with you, you can generate additional income to enhance your present business and you could benefit from reduced costs, particularly if you are already trying to administer your own secured loans scheme.
