By Ian Pollock
Personal finance reporter, BBC News
Kensington pitches for business
The crisis at the Northern Rock, and the subsequent retrenchment among other mortgage lenders, has thrown a spotlight on a seemingly odd, niche business.
Known in the trade as "sub-prime, buy-to-let" it involves lending money to people with bad credit histories who want to become buy-to-let landlords.
Only last week the Bank of England, in its half-yearly financial stability review, warned that there were various groups of people and companies whose finances were now more vulnerable as a result of higher interest rates and the recent turmoil in the financial markets.
One group it highlighted was sub-prime borrowers who, by definition, have a recent history of not being able to pay some of their debts such as rent, credit card bills, or mortgage payments.
Yet there are still lenders happy and willing to lend money to some of these people who also want to set themselves up as landlords - another potentially risky business if house prices stagnate or even fall.
The total number of mortgages being offered to the public has shrunk by 40% in the past three months, according to a recent report by financial information service Moneyfacts.
Many people are able to get back on their financial feet relatively quickly
Alex Hammond, Kensington Mortgages
The biggest fall was seen among the sub-prime, buy-to-let variety, with the number on offer falling by nearly three-quarters.
"Borrowers are now less likely to find a sub-prime lender that will accept extra heavy or unlimited adverse credit," said Moneyfacts.
Even so, there are still four lenders offering 239 such mortgages between them.
And the total market of nearly 300 current deals involves not just niche lenders but also some of the biggest names in general mortgage lending, such as the Nationwide, the Alliance & Leicester, and the Chelsea building society.
Are they mad?
The general message from all these lenders is that they are in fact very choosy about who they lend to, and therefore they are not really taking an exceptional risk in lending them the money.
Kensington Mortgages has been going for ten years and regards itself as a pioneer in this market, according to spokesman Alex Hammond.
The Mortgage Works is run by the Nationwide building society
"Borrowers can receive an adverse credit history for a number of reasons, often as a result of unexpected circumstance, such as divorce, redundancy or illness," said Mr Hammond.
"These are all things that could happen to anyone and they have the potential to damage your finances for a short period of time.
"Many people are able to get back on their financial feet relatively quickly," he added.
Deposits and rates
Typically borrowers have to put down a 25% deposit, which, assuming the money has come from their own finances, suggests they do not have a high risk of going bust.
They also have to be prepared to pay higher than normal interest rates, with
Kensington currently charging 8.3%.
The Alliance & Leicester, which offers just one mortgage of this type, charges 8.04% but demands a deposit of only 15%.
"Alliance & Leicester would require the buy-to-let to be self-funding," said a spokeswoman.
"The landlord must own their current residence or buy-to-let property and be fully up to date with all mortgage payments at the time of application."
Attitudes vary a lot among lenders.
The Chelsea building society, for example, lends at a fixed 6.15% for the first two years, with the loan rate reverting to its standard variable rate, plus an extra 0.25%, making 8.24%.
It is also prepared to be quite flexible about an applicant's bad debts.
It will not tolerate any rent or mortgage arrears in the past 12 months, but it will ignore any credit card defaults or county court judgements, even ones that have still to be paid off.
"Our criteria are much stricter than other lenders, we are much more prudent," said a spokeswoman.
"We have no problems or concerns with it," she added.
On the face of it mortgages like these appear to combine two risks into one - people who cannot run their finances properly who are also taking part in a speculative venture in the property market.
Ray Boulger of John Charcol
It is a view shared by Ray Boulger of mortgage brokers John Charcol.
"For anyone who has adverse credit, investing in a buy-to-let does not make sense", he said.
All types of buy-to-let mortgages now make up about 8% of outstanding UK mortgages and their default rate is less than for mortgages generally.
But Ray Boulger makes the obvious point that sub-prime, buy-to-let deals are more expensive.
"They have higher interest rates and they require a high level of rental income to pay the mortgage," he said.
"Some people would be better off trying to pay off their debts and repairing their credit status to get a cheaper mainstream loan," he added.
Few borrowers, few problems
So far there seems no evidence that those who have taken sub-prime, buy-to-let mortgages have seen their financial problems compounded.
In the first half of this year, only 0.6% of all buy-to-let mortgages were 3 months or more in arrears, a smaller proportion than for all mortgages generally.
"We don't have any clients who fall into this category," said Frances Walker of the Consumer Credit Counselling Service.
In fact, given the booming house prices of the past few years, such an investment may, so far, have been a very clever one.
The lenders say that in fact they make very few loans on this basis, with most applicants having to go through a mortgage broker rather than being able to apply to a lender directly.
"The sub-prime buy-to-let market makes up a very small proportion of our overall non-conforming business," said a spokesman for Preferred Mortgages and its sister outfit SPML.
But common sense suggests that as house prices slowdown and the impact of higher interest rates becomes evident in higher mortgage rates, then some borrowers and lenders will find out they have made a mistake.
"Get your houses in order before looking for something else in which to invest," advised Malcolm Harrison of the Association of Residential Letting Agents.