Following on from my last blog, Capacity, on the 3 C’s of mortgage lending this second instalment focuses on mortgage lending commitment.
I learned my mortgage principles ‘old school’ as my very first full time job out of college was at Cheltenham & Gloucester in Holborn in1999. This is relevant as mortgage applications back then were underwritten, processed and then sanctioned all from that office.
The managers had differing levels of underwriting mandate. (So a Junior Manager could sign off mortgages up to £250,000, a senior Manager up to £500,000 and the Branch Manager well over £1m) with only very large, complex or risky loans having to go to the Head Office in Gloucester for final sign off.
This gave me a really great understanding of how and why mortgages were granted (except for the age old trick of a broker taking a manager out for a boozy lunch to get stuff agreed…)
The principles of mortgage lending
So in these series of blogs I am going to go over my core lessons on mortgage lending – The 3 C’s, which are:
Being the second in the series, I’ll start with the second aspect – Commitment
Mortgage Lending Commitment
If you are outside of the mortgage lending world, your mortgage lending ‘commitment’ would most likely be assessed by your credit score these days, but there are other important factors which I will touch on.
So in a very simple sense – how likely does an underwriter feel it will be that you will make your payments on time, and or, repay the loan in full?.
Let’s go through the key things that underwriters, or more accurately these days – credit scoring systems – look at in order to derive that decision:
Ability to take loans and pay back
This is where your credit file is possibly the most important data point any underwriter or system will look at.
Typically the data goes back 6 years for any issues on your credit file such as defaults or CCJ’s (see below for more info on that).
Lenders can look back anywhere between 1-6 years on your performance of paying your bills on time, but most lenders look over a 2-4 year timeframe.
The way I always describe this is that it is like your driving licence. You may have been naughty in the past and picked up some points, but after a time, they drop off and you have a clean bill of health. Your credit file works exactly the same. Just because your were a bit loose at Uni and missed a few payments etc, that isn’t going to be a factor 10 years down the line when you come to get a mortgage. Lenders do live in the real work and it is trends that are useful for them. So if you haven’t missed any payments in the last 2 years (or maybe even never at all), that is quite a good indication you have your finances in order and are likely to pay in future or not enter into an arrangement you cannot fulfil.
Perversely, this is where not having taken loans in the past doesn’t help.
You would think logically (and correctly in my opinion also) that as you have never taken out any debt in the past surely that makes you a great bet going forward? Taken from the perspective above, no, it doesn’t, as you have no experience of borrowing and repaying money.
The underwriter doesn’t actually know if you are a good bet or not as they can’t evidence that you have repaid debt. That said, it certainly will never stop you getting a mortgage if you have never taken out any debts, but you may find that you get a low credit score or maybe even fail a lenders credit scoring system for that reason, that does happen.
But not all lenders credit score, some just credit check, and clearly when you check and there are no issues, any sensible mortgage lender will offer you a loan. It is for that reason you can fail a credit score as there just simply isn’t enough data to pass the lenders internal system, but that is not a negative reflection on you, purely just a ‘computer says no’ situation. Thankfully, not all lenders take that approach
Level of deposit
The level of deposit you put in plays a huge role, and is often the argument against low deposit or 100% mortgages. If you don’t ‘have skin in the game’ what is to stop you walking away from the debt?
It’s a strong argument and in the context of mortgage lending commitment, a very large factor.
If you put in £5k toward a property purchase, yes it would sting if you lost it, but it wouldn’t be the end of the world. If you put in £100k and had saved for years, worked your tail off to get the money or your family had helped you, would you be so quick to walk away? The answer is very clear and this is why the level of deposit is a huge factor for mortgage lenders when they are ascertaining if you are a good risk to lend too or not.
That isn’t to say that just because you have a small deposit (or maybe even none in the future) you are a bad risk. Quite to the contrary.
Young people on an upward curve who haven’t had family assistance, or simply had time to build up a large deposit, are as good a bet as anyone. Indeed maybe even more so as they have put their own sweat and tears into being able to be in a position to buy a property. It just exposes the lender. If you have a 5% deposit day 1, you lose your job and can’t pay the mortgage, it only takes a 2-3% fall in house prices and accumulated interest for the lender to make a loss on the loan, hence why more hoops typically need to be jumped through in this area.
Repossession rates in the UK have been well below 1% of mortgage holders for 30 years or more. So underwriting in the UK, whether system or human led has proved to be very robust over time. This is often misunderstood where people blame 100% (+) mortgages for the credit crunch in 2008. Yes, these loans were to blame, but they originated in the US and often were mixed in with mortgages for people with bad credit (see below).
Banks like Lehman brothers (and just about everyone else) had blended, mixed, chopped and repackaged mortgage backed securities to the extent that investors no longer knew what they were holding. Hence the lack of faith in the system and ensuing credit crunch. Watching The Big Short is worth your time if you are interested in this period as it is summed up so well. Ultimately credit only flows when there is faith in the system. No faith, no money. A modern religion if ever there was one…
Adverse credit and late payments
Closely linked to the point above, if you haven’t paid money on time previously, it is natural that lenders will lack faith and question your mortgage lending commitment.
Again, I go back to the point that lenders do live in the real world and as we know all too well of late, sh*t happens. So this is where an explanation is essential.
If you have missed one direct debit in the last 2 years, which was down to a technical mishap on your direct debit, will most lenders care? No, as it is clear from the rest of the data for you that this was out of character and not something to be overly concerned with.
However, and big risk warning – the smaller your deposit the more of an issue this becomes (and take on board the points above you see why).
Some lenders will decline a loan if they see any missed payments at all if you have a 5-10% deposit. In fairness, that is their prerogative and to be blunt, they don’t have to lend you a penny if they don’t want to, it is their money after all and they have to draw the line somewhere. Unless you are the UK Government and just print money when it suits you, most lenders have a limit to what they can lend so they will be more cautious in areas they deem more risky.
Nothing is more risky to a lender, than lending to someone who has a history of not paying money back. So if you have had issues, expect lenders to either insist on larger deposits, higher interest rates, or more stringent underwriting. Again, I go back to the same point that lenders live in the real world, and if there is a clear ‘life event’ which affected you, some lenders will take a view.
Again, this is where a credit file is very valuable. You could have someone with an impeccable credit history, but 3 years ago had credit issues, but in the past 2 years has also been immaculate. Why is that? What happened and is it likely to happen again? The cause of this could be anything, but common things like a family bereavement, relationship breakdown, mental health issues, a traumatic event, failed business venture etc are often the root cause.
So a lender has to have comfort that whatever created the issue isn’t likely to happen again. This is why the explanation is so important and the behavioural factors that drove that. Let’s say you were diagnosed with cancer and had to stop work. That left you in debt and meant you had missed mortgage payments, until you sold the property. Once sold, you repaid your debts and have never had an issue since. That scenario (while also highlighting the need to protect your mortgage as this safeguards against making a bad situation worse!) is understandable and most lenders will be sympathetic. If it was a case of – I had money, but hitting Vegas with the boys was more important than paying my mortgage on time (and going all in on Black didn’t pay off) – you are likely to receive less understanding and it make take time to repair the damage that is done on your credit file, or accept more punitive terms in the interim.
It all goes back to that question of faith. When lenders believe you will pay on time, their credit flows. If they do not, it is much harder work.
That also explains why large economic shocks affect lending. Perversely that can also create a self-fulfilling prophecy, as if lenders do not believe that the jobs will be there to support loan repayments, then loans seize up. Without liquidity it is harder to create more jobs, and you are on a downward spiral. This also explains why so many Governments showed so much commitment to the economy with loans and grants during Covid. As such, the credit has been flowing like no other time in history in fact. The Government’s commitment to back loans and sectors of the economy that needed it, has vastly reduced what could have been a savaging of the UK economy. Let’s hope that faith is repaid with the ‘bounce back’ we are expecting. But if faith and commitment are key drivers, you would suspect that this gamble has paid off. This time…
So hopefully the above adds some colour as to the thought processes, and sometimes seemingly odd decisions, mortgage lenders make when granting loans. Mortgage lending commitment is really the key factor. As simply talking your bank manager into a loan is no longer (or certainly very rarely) an option, it is the outward data points that we can try to ascertain to establish someone’s commitment to a loan and the probability they will pay the loan back.