Equifinance – A guide to adverse credit in a regulated market

18 July 2016

Tony Marshall, Managing Director of specialist lender Equifinance, explains how second charge mortgages can help brokers with clients deemed as ‘adverse’ and the role secured lending can play in helping provide consumers with access to financial products they may otherwise be denied.

What does Adverse Really Mean?
The word ‘adverse’ has many connotations in the minds of financial advisers and mortgage brokers – to some it means lending is not possible to this type of client, to others it’s seen as an opportunity to investigate further and see if financial products can be provided.

Within financial services the term came to fame as the phrase to blame for the credit crunch in 2007. Too much reliance on lending and selling on of ‘toxic debt’ based on sub-prime mortgages. The financial castle was built on sand and the tides of recession hit it hard. To its credit the financial markets have recovered well, and we are now in a new era of stability and possibility. The second charge market epitomizes this new world order, offering products in a newly regulated sector responsibly.

So could ‘adverse lending’ lose its bad name? There are many reasons and we will discuss these later, but it’s essentially a combination of lenders working more closely with brokers and their clients for long term benefits, and the regulator taking responsibility to implement changes that benefit consumers while at the same time opening up potential new business avenues for lenders.

What Constitutes an Adverse Client?
There can be many reasons for a client becoming an adverse customer, but ultimately it means that those customers, fall into a category of not being able to get finance from a mainstream lender.

Adverse in this context usually means a poor credit record, such as CCJs, defaults, missed payments on credit, bankruptcy or an ongoing or previous arrangement with creditors be that arrangement formal or informal in nature. Niche lending might also include unusual job types, recent changes in employment such as newly self-employed, or the client lives in a particular property type and of course customers may fall into one or both camps. However all of this does not mean that the customer is a bad person, nor is it necessarily an indication of future delinquency. Invariably a large proportion of customers who arrive at an adverse or niche lender do so in good faith and often turn out to be good borrowers. Sometimes it is just that the customer’s situation or circumstances do not fit prime products or they have experienced short term issues in the past such as loss of earnings, divorce, illness or bereavement that affected their ability to service debts.

Financial Access – the Door Should be Open
It’s very easy for us to think everyone has access to the basic financial services they need. The FCA in their Occasional Paper no. 17 published in May 2016, highlighted the need for consumers to have access to a variety of financial products over their lifetime, which can be difficult when the sector is driven by market forces. Access can be denied for a variety of reasons such as customer age, knowledge, a poor credit rating, a disability, their type of job or length of time in a role, where they live and for how long, or a lack of other financial products such as a bank account.

Secured lending can help customers in a number of different circumstances to meet their longer term financial goals whilst providing adequate security and return for the lender.

Uses for Second Charges are Growing
Since MCD came into effect in April, the awareness of second charge mortgages has been brought into sharp focus, mainly because they now need to be considered as a viable option alongside a re-mortgage. They also now have the same loan application process and documentation.

When it comes to clients with less than prime circumstances second charge mortgages can provide solutions in a number of situations to help homeowners.

Some common uses which many brokers have been aware of for a while are to retain an existing low interest rate on their first charge while borrowing separately for home improvements or another major purchase. This option is often better than a full re-mortgage particularly if the first charge is still within the early redemption charges period.

But other uses have come to the fore recently such as using a second charge to exit a client from a debt management plan (DMP). Entering into a DMP can be a useful step in getting a client’s finances reorganised so as to avoid more serious difficulties later. However, a DMP is a facility that needs to be carefully monitored to ensure it doesn’t exacerbate the problems in the longer term. Remaining in a DMP for the long term might also restrict the customer’s options such as moving to another house where they need a new mortgage or changing their car where finance is required. In short, a DMP could reduce the client’s access to other financial services, and delay recovery.

MCD and the New Dawn
MCD has opened up a new way of thinking as lenders have reviewed their processes to accommodate the new regulation. Many lenders have reported improved efficiences and a have re-evaluated their systems as a result, which in turn has improved the opportunities for brokers, product development and speed of service.

MCD has been a catalyst for the launch of many sourcing systems to help brokers decide on the right second charge for clients when compared to a re-mortgage. However, the sourcing systems can only act as a guide when it comes to adverse cases. In the adverse/niche sector nothing compares to an experienced underwriter assessing each individual case on its own merits.

Where Now for Adverse Credit Lending?
It has become clear this year that no matter what makes a client ‘adverse or niche’ the situation can be expertly reviewed and a potential way to access finance can be proposed. Individual assessment is vital, but there are also more lenders with wider product criteria to cater for adverse cases.

It is important that products such as second charges are accessible to clients with a less than perfect credit profile or unusual circumstances. In addition, made available when required in a client’s financial life cycle and perhaps used as a stepping stone to longer term financial recovery, re-establishing a good credit history and in some circumstances to prevent an ongoing spiral of debt.

The ultimate goal is to help the client achieve an improved outcome with benefits such as access to a wider range of products and release from the restrictions that an adverse profile might impose.