MortgagesFeb 8 2018

What is subprime and has the market changed since 2007?

twitter-iconfacebook-iconlinkedin-iconmail-iconprint-icon
Search supported by
What is subprime and has the market changed since 2007?

But perhaps none more so than the subprime mortgage market and, more specifically, the US part of the market.

Ask people how and why the financial crash happened 10 years ago and most will answer that it was largely because some of the biggest lenders, both in the UK and US, offered mortgages to those who could not afford to keep up repayments.

It is a rather simplistic version of events but it does go some way to explaining why subprime is something of a ‘dirty word’ in financial services, especially as many bad mortgage debts were being wrapped up into collateralised debt obligations (CDOs) and pumped into the fixed income market, which precipitated the credit crisis.

Many of those investment banks involved in this securitisation, such as Bear Stearns and Lehman Brothers, nor longer exist. And lenders with large subprime loan books, such as Northern Rock, are no longer a feature on our high street.

The term 'subprime' therefore comes with a certain amount of history, but the concept behind subprime still prevails.

Definition 

What exactly does subprime mean in the context of the mortgage market?

The term largely refers to those who perhaps have a poor credit history and who may have struggled with repayments in the past but who want to be able to take out a mortgage in order to purchase property.

Charlotte Nelson, press officer at Moneyfacts, confirms that credit impaired mortgages or subprime mortgages, as they were once known, are useful to help borrowers with poor credit ratings to get onto the property ladder.

Ray Boulger, senior mortgage technical manager at John Charcol, explains: “The definition of subprime varies depending on the lender, but in any case UK lenders now prefer to use euphemisms such as credit repair and adverse credit.”

The connotations associated with ‘sub-prime’ are based on a very different market compared to what we have now.Jeremy Duncombe

Some lenders have rebranded subprime mortgage products as credit repair, credit adverse or more generally, see it as falling into the specialist lending category.

Mr Boulger reminds advisers of the scale of the problem leading up to the crash of 2007, suggesting “mortgages were available to people with very heavy adverse credit, providing they had sufficient deposit/equity. It was even possible to apply for a mortgage the day after coming out of bankruptcy”.

It is no wonder the market is trying to move on from 2007.

Jeremy Duncombe, currently director at Legal & General Mortgage Club, says: “The connotations associated with ‘sub-prime’ are based on a very different market compared to what we have now. 

“As a result, it’s unhelpful and inaccurate to use 'subprime' as a term to describe the current specialist lending market.”

Learning from mistakes

How was the subprime market allowed to thrive in the years before and leading up to 2007-2008 then?

Mr Duncombe recalls: “A combination of self-certified mortgages, looser affordability checks and high loan-to-value (LTVs), in some instances over 100 per cent, created the subprime market of 2006.”

David Torpey, chief operating officer at Bluestone Mortgages, notes: “Pre-crisis, the majority of specialist lenders were owned by investment banks like Lehman Brothers, Merrill Lynch and Bear Stearns. 

“These banks would originate and securitise loans as soon as possible post-origination and were able to transfer the entire risk exposure into the securitisation vehicle.”

Put simply, as Ms Nelson remembers, back in 2007 “the level of credit impairment was vast, with borrowers with severe credit issues being offered a mortgage”.

Since then, not only has the name of the market changed but, far more than that, lending and affordability guidelines are subject to more scrutiny.

Mortgage lenders now focus on proven income, expenditure and stress testing to ensure that the mortgage, and all other commitments, are affordable.David Torpey

Ms Nelson reassures borrowers: “The market has learned from the past, which means stricter rules are now firmly in place, with many of the lenders offering these deals looking more in-depth into a borrower’s history.”

Mr Torpey also believes the specialist lending market in the UK has changed considerably since 2007.

“Before the financial crisis, the market was dominated by self-certified mortgages, which were banned by the FCA after the crash,” he reasons. 

“Mortgage lenders now focus on proven income, expenditure and stress testing to ensure that the mortgage, and all other commitments, are affordable in the current and future interest rate environment.”

More robust checks

He also insists that the banks’ ability to originate and securitise loans as quickly as possible, which he referred to earlier in this article, is now no longer possible, thanks to regulation imposed since by both the Financial Conduct Authority and the Prudential Regulation Authority.

“Current regulation now ensures there is a minimum 5 per cent risk retention for securitisation vehicles in Europe,” Mr Torpey reasons. 

“Other changes, like loan-to-income (LTI) limits of 4.5 times the borrower’s income, and the significant reduction in the availability of interest-only loans has also had an impact. Combined with the checks put in place after the financial crisis, these changes have led to the far more stable and controlled financial system today.”

Mr Duncombe is also confident the factors that contributed to the financial crisis a decade ago do not exist in the subprime mortgage market anymore.

He acknowledges: “The specialist market is underpinned by the same affordability, regulation and stress protection tests as the rest of the market. 

“Specialist lending is a natural extension of the mainstream market and a decade on from the financial crisis, the reforms and checks put in place have built a far safer and more robust financial system.”

eleanor.duncan@ft.com