By Ian Pollock
Personal finance reporter, BBC News
Mortgage applications may eventually be scrutinised much more tightly
A startling fact about mortgage lending was highlighted by the Financial Services Authority (FSA) this week.
At a conference on the future of the industry, a senior FSA official pointed out that by 2007, at the height of the lending boom, 45% of all mortgages were being granted without the lenders checking if the borrower's stated income was correct.
It is now clear that the FSA has this sort of practice very much in its sights.
"We have found substantive evidence of irresponsible lending and inadequate affordability assessment," said Jon Pain, a managing director at the FSA.
"We will ask whether we should change our rules to require income verification for all mortgages, with lenders required to verify the plausibility and authenticity of the documentation by the customer before an offer is made," he added.
Most people will be surprised that lenders had got into the habit of lending billions of pounds to people without, apparently, making basic checks on their ability to repay.
Mr Pain pointed out that a lot of this involved so-called "fast track" lending, with minimal or no checks on income by lenders.
Alternatively, lenders relied on mortgage brokers to do their checking for them.
He said this was irresponsible and involved "lenders considering affordability checks not to be their responsibility, but that of the intermediary."
A lot of the unchecked lending also involved "self-certified" mortgages - ones where the borrowers were not even expected to prove a certain level of income to sustain their ability to repay.
In some quarters these have been dubbed "liars loans", giving the borrowers a convenient way of dodging sensible lending restrictions.
When first conceived, they were aimed at letting some people, such as the self-employed and contractors, obtain a mortgage even if their income was irregular and lumpy.
What has clearly surprised the regulator is the extent to which this sort of loan has been extended even to borrowers in paid employment.
"We have seen a significant increase in the amount of self-certified lending to employed customers for no perceptible reasons," said Mr Pain.
Bernard Clarke of the Council of Mortgage Lenders (CML) said it was important to distinguish between the different types of lending fingered by the FSA.
Jon Pain, retail managing director, FSA
"There is a very clear distinction between fast-track lending and self-certified lending," he said.
"Fast-tracking is a process which involves low-risk loans, borrowers with very good payment records and people who are borrowing conservatively," he explained.
Ray Boulger at the brokers John Charcol points out that the FSA has been happy for almost all lenders to rely heavily on credit scores provided by agencies such as Experian and Equifax to assess their borrowers.
"Lenders say that credit scoring is a better way of predicting someone's ability to repay," he said.
"Lenders will audit a percentage of fast-track applications to check them manually - and responsible lenders and brokers already check the plausibility of applications," he added.
The problem is that not everyone is responsible, or even honest.
The FSA has been busy in the past year banning and fining fraudulent mortgage brokers.
And it says a lot of the money lent by specialist lenders under the banner of self-certification has led to large numbers of arrears and frauds.
But why should some lenders have been so keen to extend apparently risky loans?
Mr Pain analysed their outlook as follows:
"Some lenders, knowing they ultimately do not bear the financial risk of consumers' inability to pay, [have not worried] about affordability, either because they can sell on the mortgages by packaging them up and selling them on; or they believe they can rely on house prices to rise, [with] repossession ultimately providing a safety net - but not for the consumer."
When the FSA first took over the regulation of mortgage selling a few years ago, it proposed at the time that employed borrowers should not be allowed to self-certify their incomes.
The mortgage industry lobbied against that idea and the FSA relented.
Not surprisingly, it now regrets that decision and will almost certainly not allow this to happen in the future.
"With hindsight this may have been a mistake," said Mr Pain.
The FSA's chairman, Lord Turner, made it clear that he was not convinced that mortgage lending should be controlled by crude limits on individual borrowers when he published his initial review of mortgage lending in March.
This might, in theory, be achieved by capping the size of loans, either in relation to the size of a property's value (loan-to-value) or the size of a borrower's income (loan-to-income).
He is still unconvinced about those ideas, though he is open to persuasion. But that does not mean that nothing will change.
The FSA launches in September a full consultation on the future regulation of mortgage lending.
And it looks as if it intends to demand a much higher level of both scrutiny and honesty from the industry, including its customers.