Poor Practices in Sub-Prime Mortgage Market

While the global stock markets have been affected by the problem of sub-prime mortgages, the financial regulators are doing something to find out the root causes.

Last month FSA published its latest review of the behavior of intermediaries and lenders within the sub-prime mortgage market, which services consumers with impaired credit histories. It has found weaknesses in lending practices and in firms' assessments of a consumer's ability to afford a mortgage. As a result the regulator has started enforcement action against five firms.

The thematic work reviewed 11 lender firms, representing more than 50% of the sub prime market by volume of sales. It also included 34 intermediary firms covering 485 customer files, of which 90 were tracked from the contact made with an intermediary through to the lender's decision.

While the research found no significant evidence of sub-prime mortgages being sold incorrectly to prime customers, several other issues were identified for both intermediaries and lenders when selling to sub-prime customers.

For Intermediaries:

• In a third of the files reviewed there was an inadequate assessment of consumers' ability to afford the mortgage.
• In almost half of the files there was an inadequate assessment of customers' suitability (e.g. needs and circumstances) for the mortgage.
• In over half of the files customers had self certified their income but it was not clear in many cases why they had been advised to do this.
• Significant numbers of consumers were advised to re-mortgage, thereby incurring early repayment charges, without the adviser being able to demonstrate that this was beneficial to the customer.

For Lenders the main weaknesses were found in their lending policies:

• None of the lenders adequately covered all relevant lending considerations in their policies. For example, some firms' lending policies contained unclear affordability or self-certification requirements.
• In many cases, lenders did not apply their own policies in practice. For example, some firms failed to check the plausibility of information, as required by their own lending policy.
• There were also failings by lenders to monitor the application of their policies, which resulted in the approval of potentially unaffordable mortgages.

While the suitability requirements have been applied to selling of investment products, they are also relevant to selling of high risk sub-prime mortgage products.