There has been significant growth in the number of lenders offering secured lending to people with credit problems, including those who have been bankrupt, have County Court Judgments logged against them, and for purposes such as debt consolidation. As consumer credit debt tops an eye-watering £1.2 trillion in the UK, it is no wonder that the major lenders in the UK and some significant players from abroad have been falling over themselves to get a slice of the growing sub-prime cake in the UK.

But for the IFA there is need for caution. The evolution of the UK sub-prime market needs to be examined and the implications for those who are active in it examined. From an IFA’s perspective, get sub-prime business wrong and the consequences could be serious.

Several factors caused a growth in demand for sub-prime mortgages in the mid-1990s. These include: mainstream lenders automating credit-scoring procedures; more people with previous debt repayment problems; more marginal borrowers seeking loans for home-ownership and, in the late 1990s, soaring levels of borrowing for consolidation of debts as interest rates rose. Since the early 1990s, a range of factors has created circumstances in which both the demand for, and the supply of, sub-prime lending has flourished.

Following the 1990s recession, more people suffered some episode that had harmed their credit rating – whether from house repossession, falling into arrears with housing or utility payments, which were pursued more aggressively by privatised companies, having had a CCJ or being made bankrupt. Reflecting broader labour market changes, more people had flexible contracts or terms of employment and income that was variable or hard to confirm. Mainstream lenders, which had suffered during the housing market recession, reacted by exercising extreme prudence in lending, particularly using mechanised and centralised credit-scoring mechanisms to select only low-risk borrowers.

Individualised

The UK sub-prime sector started to evolve from the mid-1990s with the entry of specialist lenders. These saw a niche for lenders building on a more individualised approach to underwriting and pricing the risks involved in lending to sub-prime borrowers. Luckily a buoyant property market has covered up any deficiencies in the risk pricing models. House prices have more than doubled in the past decade, so it is not advisable to heap too much praise on the sub-prime lending actuaries.

A greater proportion of borrowers in the sub-prime sector are in arrears than those in the mainstream sector, as might be expected, around 10 per cent to 15 per cent in 2004. There is also evidence that sub-prime lenders move towards possession more quickly once arrears start to accumulate, on both first and, especially, second mortgages. Now there is a new raft of specialist sub-prime to sub-prime lenders which are mopping up the heavy adverse clients. Competition would on the face of it seem like good news for sub-prime clients and intermediaries active in this segment. This year there are expected to be six new entrants in the UK sub-prime mortgage market.

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