The self-certified mortgage timebomb

Home loans granted to borrowers who simply declare their income are soaring, says William Kay. But some extend themselves so much it could all end in tears if the economy keeps plunging

A furious behind-the-scenes row is developing over the future of self-certification mortgages, where borrowers are allowed to state their own income in return for putting up a larger than normal deposit. Datamonitor, the business information company, this week published a report which describes these mortgages as "a timebomb waiting to explode if the economy takes a turn for the worse".

But Ray Boulger of Charcol, the mortgage specialist owned by Bradford & Bingley, said: "Lenders have access to better-quality information about borrowers nowadays, and no one is going to put up 20 per cent or more of the cost of a property with the intention of defaulting."

Self-cert mortgages began 15 years ago and were initially confined to the self-employed or people running their own businesses. Because they could not comply with the normal requirement to supply a payslip as proof of earnings, they were allowed to self-certify. This involves giving the would-be lender a signed declaration of earnings, often with an accountant's confirmation. As such income tended to be more volatile than usual, these loans were deemed riskier. so the interest rate would be higher.

But low interest rates have made it easier to bear such a penalty, especially as house prices have continued to soar. Changing employment patterns have attracted more people to self-cert, including contract and home workers, part-timers and those with more than one job. This brought dozens of mainstream lenders into this specialist market, boosting its lending to a record £9.8bn last year. It has grown by more than a quarter in each of the past five years, and now accounts for 5 per cent of all mortgage lending.

"Without self-certifying, we simply could not have afforded our new car and extension," Patrick Carter, a property consultant in Somerset, said. Mr Carter's basic salary is only £15,000 a year. But for the past four years he has also earned annual commission of £17,000. His wife, Elaine, is a part-time school nurse on £6,000 a year.

The Carters, with two children, Nicholas, eight, and Sonia, 16, wanted to remortgage to build an extension and buy a new car. Their house is worth £325,000, with a mortgage of £87,000, but they wanted £50,000 more, making a total borrowing of £137,000, or 42 per cent of the property value. But, because Mrs Carter works only part-time, and standard lending yardsticks allow only half Mr Carter's commission, they would not be able to borrow enough.

Park Row Independent Mortgages advised them to self-certify and arranged a loan from Standard Life bank, which self-certifies for loans of less than 75 per cent of value. "All we were asked for were our passports, last mortgage statement and utility bill to show residency for the last three months," Mr Carter said.

Although their income had to be stated on the application form, and they had to provide their employer's details, they have not been asked for any proof of income and no checks will be made with the employer. Because the mortgage is self-certified, Mr Carter's commission can be added to his income and worked out on an affordability calculation rather than normal income multiples. When the Carter income is added together, they could have borrowed as much as £142,000.

But irregular earnings are much more slippery than those from regular employment so the fear is this boom will expose lenders to much higher risk. In the orthodox situation, an employee provides proof of earnings and agrees a mortgage of a set multiple of those earnings, usually three or four times with adjustments for spouse's pay.

But with self-cert there is an obvious incentive for would-be borrowers to exaggerate their income so they can buy that must-have house. Brokers are also encouraged to collude because commission paid on self-cert mortgages is often higher than on orthodox loans.

Datamonitor's Edward Ripley said: "There is also a growing belief that less documentation does not mean greater risk and that the most useful information is supplied electronically by the credit reference agencies and from other sources. And self-certification mortgages can be provided more efficiently since it is not necessary to expend time and effort seeking documentation which adds little to the ability to make the right lending decision."

The image of self-certified mortgage is not helped by First National Bank, which is being sold by Abbey National to GE Capital. It offers loans from £35,000 and 90 per cent of value to borrowers with up to three county court judgments. Although this area is governed by a voluntary code, there will be no statutory regulation until the Financial Services Authority assumes responsibility next year.

Mr Ripley believes the market will grow at 12.4 per cent a year on average over the next five years, and will be worth more than £19bn by 2007. He added: "Although 'income-stretching' is not necessarily a problem when interest rates and unemployment remain low, the market could be a timebomb waiting to explode if macroeconomic conditions worsen."

But Mr Boulger said the high minimum deposit is a safeguard against corruption. He said: "If someone can put up a quarter of the property's value, why not go the self-cert route? It is much quicker without having to prove earnings, and many lenders are charging no extra for it."

Charles Reed, managing director of UCB Home Loans, part of Nationwide Building Society, said: "We have had rapid growth in self-certified mortgages, because there are more people adopting flexible career paths, so it makes sense for lenders to be more flexible too.

"I understand the concerns, but it boils down to expertise and underwriting skills, and we have been in this sector for 15 years. There is a danger that people will see self-certified as being for non-status borrowers, but we concentrate on lending to people who are low-risk. Our arrears rate is very low."