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Prudence adds an edge

With low inflation and interest rates now the norm, should lenders aim to relax credit criteria so they can lend more to customers?

A much stronger argument can be made for sticking to the traditional principles of prudent lending, which will enable everyone involved in mortgage lending to enjoy the benefits of enhanced business relationships.

The mortgage market is experiencing unprecedented regulatory scrutiny, with the FSA about to publish its discussion paper on how it intends to proceed with the regulation of mortgage lending. So far, it is unclear what will happen about the regulation of mortgage advice and how far the MCB will look to lenders to ensure advisers give good advice at the point of contact with consumers.

Whatever the eventual outcome, one thing is certain – mortgage advisers must be prepared for closer scrutiny of all aspects of their activity, they must be able to justify fully their choice of lenders and understand that the principles of prudent lending can only work to enhance the way advisers choose which lenders to recommend. However, this is no bad thing for a mortgage adviser&#39s business because using these principles will bring many benefits, such as quicker lending decisions and enhanced customer relationships

Going back to basics, prudent lending from the point of view of lenders and borrowers is made up of two elements. First, the property must be a sound security and represent fair value. Second, the borrower must be creditworthy – in other words, willing and able to make repayments. Taking both these factors into account, the lender can stipulate what proportion of the property price or current value it will allow the applicant to borrow.

In current mortgage lending practice, these elements have been reduced to two sets of easily measurable facts (increasingly to satisfy the demands of automated credit scoring systems): a sum produced by applying an income multiplier to the applicant&#39s income and the loan to value ratio. If the income multiplier (minus any other major regular financial commitments) produces a figure which covers the size of the loan, and if the would be borrower only wants a reasonable percentage of the property&#39s value, it is generally regarded as prudent lending.

These two features can act as a counterpoint to each other. A lender may be prepared to underwrite a loan at higher than normal income multiples so long as there is a reasonably low LTV so that security in the loan is still good. On the other hand, lenders offering LTVs of 90 per cent and above will want to be sure of the applicant&#39s ability to make repayments and therefore will be unwilling to be flexible about income multiples.

Partly due to the vastly increased use of credit scoring, income multiples and LTVs have become so firmly established as the twin guardians of prudent borrowing/ lending that any criticism of over-lax policies tends to be expressed in terms which cite one of them. For example, a regular subject that the personal financial pages of the national papers cover is the dangerously high level of income multiples. The argument goes that sustained low inflation and interest rates are not guaranteed for ever and that a cyclical economic downturn will be disastrous to those who have overstretched themselves. This argument is difficult to set aside. Similarly, lenders offering 100 per cent or higher LTV are also regularly highlighted as putting such borrowers at risk.

However, prudent lending is not just about the basic good sense of reasonable income multipliers and LTVs but about making judgements about whole situations. For example, formerly, when every mortgage loan was personally authorised by the manager of the building society branch to which a borrower had app-lied, prudent lending decisions were made by an experienced person who looked at a whole situation, not just at a limited set of facts about the applicant.

Now, in the ever increasing drive to cut costs, mainstream lenders&#39 application of rigid credit scoring systems has, in many cases, reduced this human element to zero. Yet, even with mainstream lenders, a balance of automated and manual underwriting processes is probably the ideal. An experienced underwriter who takes an holistic view will bring many factors into the lending decision. Introducers who understand this process and submit good quality applications backed by the correct documentation will be able to forge strong business partnerships with lenders. These partnerships will be the cornerstone for future business success.

A prudent lending approach allows mortgage intermediaries to offer added value because a commitment to prudence will help advisers to be more professional in their dealings with prospective clients – and not just in the altruistic sense of safeguarding their client&#39s ultimate financial interests by counselling a reasonable approach to taking on too much debt.

There are many other practical ways for advisers to build up a pattern of safety features in their advice to their mortgage clients. First, they can reinforce the message about borrowing sensibly and in a reasonable way. They also need to ensure borrowers know that they may urgently need to consider making their own provision for accidents, sickness or other circumstances that would jeopardise their regular income.

The recently published Government Green Paper on housing, Quality and Choice for All, mentions the need to boost take-up of mortgage payment protection insurance. Sceptics may point out that wider take-up of MPPI will allow the DSS to save many more millions of pounds in mortgage interest bene-fit as it aims to increase the waiting period from nine to 14 months.

However, this does not detract from the wisdom of individuals providing for their own future by arranging MPPI. The adviser who recommends MPPI will be thanked by clients who need to claim against it in future to save the roof over their heads.

On the question of the property as sound equity, experienced advisers will have a good idea of local conditions and prices and can advise additional property surveys to put the buyer&#39s mind at rest and add extra confidence for the lender.

Good title to the property is also important. There is now a selection of title insurance products on the market which not only indemnify the borrower against any claims for bad title but often mean that the conveyancing can be put on a fast track for those who need to complete quickly. Here, advisers need to research the options and know which lenders actively use title insurance.

All of these intangible factors will be taken on board by prudential underwriting. Brokers who understand this will be the ones who have the best success rate with applications.

Mortgage applicants are individuals, not just numbers being processed through a sausage machine-like decision-making process. When a case has been rejected by credit scoring, advisers are often left with no reason to explain to their clients and no information with which to rebuild the case for submission to another lender.

However, niche lenders who underwrite cases will provide someone with whom to discuss the case and will be able to give sensible reasons for a rejection.

Striving for a prudent approach to borrowing and lending can help mortgage adv- isers to cement the vital relationships which are the lifeblood of their business. After all, a lifetime relationship with clients is what every financial adviser is aiming for.

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