A wide-ranging shake-up of the mortgage market has been unveiled by the financial services regulator, aiming to prevent a return of irresponsible lending and stop borrowers taking out deals which turn out to be unaffordable.
The Financial Services Authority (FSA) said that while low interest rates have helped some borrowers, there are "real dangers" that problems are being stored away for the future, with home owners being unable to meet repayments when rates start to go up.
The body's Mortgage Market Review said loans should only be advanced where there is a reasonable expectation that the customer can repay the loan without relying on "uncertain" future house price rises.
Lenders will have to consider the impact of increases in interest rates in line with current market expectations. Income will have to be verified in every application and lenders should also place greater emphasis on regular outgoings like childcare, recreation, clothing costs and household bills.
The new rules spell the end of self-certification mortgages, often used by the self-employed, and also the end of "fast-tracked" mortgages, an accelerated approval process under which verification of income may not be asked for at the lender's discretion. Self-certification mortgages have sometimes been dubbed "liar loans" because applicants declare their own earnings.
Explaining the reasons for the changes, the report said: "While risky, lower-quality lending may currently be restricted, there is a real danger that, as funding comes back into the market and lending starts to pick up again, there will be increasing pressure on firms to consider higher-risk lending and focus more on market share than maintaining lending standards."
Interest-only mortgages should only be offered only where there is a credible plan to repay the capital, and borrowers cannot just rely on rising house price hopes. Interest-only mortgages should be considered as a "niche" product, the report said, adding: "We would expect most mainstream lending to take place on a capital and interest basis with interest-only being considered in limited circumstances."
Lenders will be able to provide new mortgages to some existing customers even where they do not meet the new affordability requirements, the FSA said.
It estimated that up to 15% of borrowers who took out mortgages between 2005 and 2010 could be in negative equity and also expressed concern about borrowers who are "trapped" into paying a high interest rate by their current lender because they are unable to go elsewhere.
The FSA wants to prevent a repeat of the "poor lending" seen in the run-up to the financial crisis, underpinned by an assumption that house prices would continue to rise.
© 2011 Press Association