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Affordability figures must add up

Do mortgage packagers and lenders pay too much for their valuations? In most areas of business, panel managers do just that – manage panels of experts to ensure the best service is delivered to their clients at the best price.

Affordability is clearly a hot topic at the moment and this has, of course, been reflected in the pages of Mortgage Strategy. In a recent article by Rosemary Gallagher she quite rightly comments: “The personal finance pages of the national newspapers warn of impending disaster as big lenders – most recently Alliance & Leicester – adopt affordability to assess clients’ borrowing limits.” (Mortgage Strategy November 14.)

In the following week’s issue Brad Baker’s article ‘Media must understand affordability’ urges mortgage firms to take steps to promote understanding of the value of using affordability to assess a customer’s borrowing level while on the next page Richard Griffiths comments that, “lenders are very protective about their affordability calculators”.

So what is all the fuss about and is it a case of educating the media or are there legitimate concerns here? Anybody who is familiar with my work and has either read any of my articles or attended my presentations on this subject will know I have been critical for many years of lenders relying on anything as primitive as income multiples and have been advocating using affordability for some time.

But that doesn’t mean the media is wrong on this occasion.

A properly assessed affordability routine is, in my view, much better than relying on income multiples. But therein lies the problem. Are all of the affordability routines in existence properly assessed?

I think the media’s concern began when the Alliance & Leicester changed its income assessment methodology as indicated in Gallagher’s piece. So why was this the one that caught the media’s attention? There were three reasons, first the company involved, second its timing and third the affordability routine itself.

Let me explain. A&L’s net mortgage lending in the fourth quarter of 2004 was almost zero. At the end of February 2005 its chief executive Richard Pym would not say whether sales had picked up. In April the chairman resigned. In August it was reported in the business press that analysts felt growth had effectively ground to a halt. It seemed that something had to change.

And change it did. Having previously decided that lending in the buy-to-let market was too risky, A&L suddenly announced it was now to enter that market. And then it introduced its new method of assessing how large a loan a customer could afford. The fact that this coincided with a period when A&L was probably looking to increase its lending (zero net lending is not a long-term option I would suggest) and when it appeared to be willing to enter potentially higher risk areas than it had previously considered prudent was surely too much of a coincidence.

Now that I have covered my first two points about the significance of the timing and who it was, let’s look at the third point – the affordability routine itself. By accessing A&L’s website it’s possible to input a number of scenarios and identify how they would affect how much a customer can borrow. And it makes for interesting reading.

It seems that A&L is working on the basis that having a child increases your monthly outgoings by a mere 30 per month, approximately 1 a day. Are they serious? Recent research by Liverpool Victoria estimates 22 per day. While not going into detail about the costs of having children I think we can safely assume that 1 per day is a serious underestimate of the cost.

But what about outgoings that are fixed as opposed to estimated, such as the monthly cost of repaying outstanding loans? You would imagine, would you not, that for every 100 of monthly loan costs that a customer has that they would reduce the amount a customer could borrow so as to reduce their proposed monthly mortgage payments by 100? Not so.

As a rough guide, A&L only seems to take three-quarters of a customer’s outstanding loan commitments into account. Quite how the customer is supposed to finance the shortfall I have no idea. Particularly odd as only last year Richard Pym said A&L had concerns about consumers’ overall levels of debt and that it was then turning down more mortgage applicants than previously as a result.

Or perhaps we’ve now come full circle. Could A&L’s new income assessment methodology have been designed as a way to increase the lender’s business volumes rather than to more accurately assess whether a customer can afford a loan? Certainly the timing of the change coupled with the apparent lack of logic in A&L’s affordability routine gives food for thought.

The other advantage for lenders is that unlike income multiples, which lenders make publicly available, with affordability routines lenders can tweak their affordability calculations as desired to vary their business volumes without anybody being any the wiser.

So perhaps the media is right to be expressing concern. Not about the fact that affordability is being used but about what is being introduced and the reasons for it. So I think Richard Griffiths is right – don’t expect lenders to share their affordability calculators any time soon. Brad Baker is also right when he says that affordability will remain an issue for the industry and the media.

So where does this leave us? A proper affordability assessment is the way forward. But we also have to be aware of its potential for being abused. Lenders must be able to justify any remarks they make about the quality of their lending being good to avoid accusations of either misleading shareholders or over-committing customers.

We know the media is on the case. The regulator shouldn’t be too far behind.

Keith Butler has been involved in the mortgage industry for 30 years. He is a regular contributor to specialist mortgage magazines as well as contributing to BBC programmes on mortgages. He is a Fellow of the Chartered Institute of Bankers.

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