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Competition time

Intense competition has been a defining characteristic of the mortgage market in recent years. The number of lenders has increased enormously and the sheer volume of deals now available to borrowers is staggering. As far as products are concerned, competition is pushing rates ever lower, taking lenders’ margins with them.

Nowhere are these forces more apparent than in the sub-prime market. This sector has seen rapid expansion in the past few years and the past year or so in particular has been a period of frantic activity.

Attracted to the sector by growing volumes and greater returns new lenders have been sprouting up with frightening regularity, so much so that two lenders have entered the market while I have been writing this article – Northern Rock and Coventry.

Entrants have been a combination of new players, established lenders venturing into fresh markets and packagers becoming fully fledged lenders. But out of all of this activity, two themes have emerged – the backing of global, specifically US, investment banks and the focus on securitisation.

Securitisation will play a big part in many of these new lenders’ strategies and it tends to play a bigger role in the sub-prime market than it does in mainstream lending. In fact, a number of lenders are first and foremost originators of debt – there to generate loans that are then bundled together and sold on.

Originating in the US where government-sponsored agencies Fannie Mae and Freddie Mac have been operating for many years, securitisation creates a secondary market for mortgage debt. It provides liquidity for consumer-facing mortgage lenders and helps improve efficiency in the market and ultimately the rates on offer to borrowers.

To the man on the street, this secondary market means little and I’m sure most people don’t even know it exists. This does not have to change and as far as borrowers are concerned, the most important thing is that securitisation does not affect the service they receive.

What borrowers might also be unaware of but which again should benefit them is the increase in lender choice. But brokers will certainly notice this and in the coming months they will have a lot more lenders to consider when helping their clients.

As well as the high profile launches of lenders such as edeus, DB Mortgages and Close Mortgages, other more familiar names have expanded into the sub-prime market. Most notably Alliance & Leicester started offering specialist mortgages last month in partnership with Lehman Brothers. And Northern Rock has announced its assault on the market, again in partnership with Lehman and again focussing solely on originating loans for the US bank.

Building societies have traditionally stayed away from the sub-prime market but a number of them have recently made the decision to offer mortgages in this area.

Towards the end of last year The Derbyshire launched a specialist brand called Salt, and other societies such as Scarborough and Cheshire have made similar moves into the sector.

Coventry is the latest building society to enter the adverse market with what looks like a pretty good offering. Along with a number of other societies it is focussing on near prime and light adverse business.

Another observation on the market given all the expansion and new lenders coming in, is that most of the talk within the industry concerns the lenders themselves, their plans for expansion and the prospects for their financial backers. There’s not been enough consideration of what will be on offer for borrowers and what market improvements they will see. Fortunately, the fact is that they should see a number of improvements following on from advances already made in recent years.

On the whole the sub-prime sector has cleaned itself up and strong com- petition has meant that borrowers with credit problems are no longer looked at with disapproving eyes. For example, whereas deals with overhanging early repayment charges were prevalent in the 1990s they are now virtually obsolete.

And features more typically associated with mainstream deals are now commonplace in sub-prime, such as remortgage incentives, no ERCs and high LTVs.

Another example of the sector expanding is the growth of the near prime market, spurred by the rise in consumer debt and the subsequent increase in the number of people with minor debts such as missed credit card or hire purchase payments.

The benefit of this for borrowers is that people are no longer pigeon-holed as either prime or sub-prime. Those with one or two minor problems are able to get a near prime deal (or even a prime deal in some cases) with a minimal rate premium. In fact, with so many grades of adverse deals there is now considerable choice across the spectrum from mainstream to unlimited adverse, with rates stepping up based on the risk to the lender.

Another development that will help borrowers is the concept of credit repair and it is good to see lenders focussing on this aspect of sub-prime lending.

Repairing people’s credit records and being accepted by mainstream lenders should be the goal for borrowers and their advisers, aside from getting loans in the first place. A number of lenders brand their sub-prime ranges as credit repair, and Accord Mortgages now offers a credit repair guarantee. This means that if a borrower meets all their payments on time during the credit repair deal period they will be eligible for prime rates when the deal finishes, regardless of the level of adverse credit at the outset.

It is impossible to talk about developments in this market without looking at technology. Despite not being mainstream, in many respects the sub-prime sector has led the way when it comes to advances in technology in the mortgage market.

Gradually the whole mortgage process from agreement in principle and full application through to credit scoring, underwriting and the final offer is being automated. The goal – and this is not just restricted to the sub-prime market – is to amalgamate all these processes and provide instant mortgage offers online.

The last link in this chain is valuation as this is the most difficult part to automate. But automated valuation models are already being used and it won’t be long before we see the first instant mortgage offers being issued. GMAC-RFC and HBOS along with edeus are hoping to introduce these shortly.

The ability to get an instant mortgage offer must be seen as good for brokers and borrowers, although it is vital that the technology is robust. At the outset I imagine the criteria for instant offers will be strict and many cases will not qualify.

We will see further developments in the market and with the number of people with debt problems unlikely to drop in the near future we should continue to see demand for sub-prime mortgages rising or holding steady. This means opportunities for new and existing lenders and for brokers, but it is important not to lose sight of borrowers.

The good news is that the image of the sub-prime sector is improving all the time but there is still more that could be done. For example, many borrowers are still being charged extortion- ate broker fees. There is always the argument that sub-prime cases mean more work for brokers but there is little justification for fees of 3%, especially given all the improvements we have seen in processing.

As far as interest rates are concerned there will no doubt be further downward pressure but this can only go so far as there will always be a premium based on the credit risk of borrowers. To compete, len-ders will need to focus more on other features and criteria such as technology and service.

Ultimately, we must remember that borrowers taking sub-prime deals are doing so not out of choice but because they can’t get mainstream deals. Successful lenders and brokers in this sector are entitled to make good returns but equally the aim should be to treat customers fairly, offer good rates, good service and a route back to the mainstream.

James Cotton is mortgage specialist at London & CountryI

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