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Flagging up US-style mortgage problems

The US is often a good indicator of what’s in store for the UK so the meltdown in the sub-prime mortgage market over there is something lenders here must steer well clear of.

Since the turn of the year, over 20 specialist US lenders have gone to the wall. There are worries that others are not far behind.

So why is this happening and what can UK lenders do to avoid what is fast becoming a financial pile-up?

In recent years there has been an unprecedented boom in US construction which has led to oversupply in the housing market. In turn, prices have flattened and in some places fallen.

So, for borrowers it has become increasingly difficult to remortgage away from their existing products. This is particularly the case for the many borrowers on 100% LTV deals.

Many US mortgages in the sub-prime sector not only carry high LTVs but also offer upfront discounted periods before rising for the rest of the term.

As borrowers are unable to remortgage away they are being hit by rising monthly payments that are crippling them. This effect has been monstrously exacerbated by 17 consecutive hikes in the base rate over the past three years, which has seen it rise from 1% to 5.25%.

While many of these loans have been sold on, investors that have bought them are able, under the terms of the contracts, to return them to the originators if they default at an early stage.

And that is what is happening. So lenders are left holding defaulting books, banks are refusing to fund further lending and nobody wants to buy sub-prime mortgage assets. It’s no surprise so many companies have gone into liquidation.

The UK’s strong underlying property demand should ensure the housing market continues to hold up. Although it is cooling, estimates see prices rising by between 4% and 6% this year.

The sub-prime market here has also been more stringent in controlling its criteria and average LTVs are well below those in the US.

As a market, we have moved away from deferred products with punitive overhangs. Indeed, intermediaries are increasingly steering their clients away from these deals except in special circumstances.

Looking at what is happening in the US, it is important for UK lenders to realise that product boun-daries cannot be pushed to the detriment of res-ponsible or sustainable lending.

Innovation is one thing but sacrificing product standards purely to swell company coffers is a dangerous exercise.

As soon as those standards are compromised, borrowers are at risk, demand for mortgage-backed securities drops and other factors such as rising interest rates can begin to have a seriously disruptive effect.

This is something the UK market must work hard to avoid. Rather than heading down the same road as US lenders, we must learn from their mistakes and be sure not to drive straight into the back of a financial pile-up.

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