By Kevin Peachey
Personal finance reporter, BBC News
Mortgage lending has been squeezed recently
All borrowers will face stricter scrutiny of their mortgage applications under new plans published by the Financial Services Authority (FSA).
At the heart of these proposals is a ban on self-certified mortgages, which do not require borrowers to prove their income.
The FSA's chief executive, Hector Sants, said that some of those who had been given home loans at the height of the housing boom would not have been able to obtain them if these proposals had been in force.
Why have this review?
The financial crisis has had a dizzying effect on the UK economy, including the £1.23 trillion residential mortgage market.
Some borrowers have been able to ride out the crisis, but others have faced severe difficulty making mortgage repayments. The situation could have been even worse if interest rates were not at a historic low.
This raised questions as to whether people borrowed much more than they could ever afford, and whether lenders were irresponsible in granting those loans.
"We believe that irresponsible borrowing has been just as much a part of the problem in the mortgage market as irresponsible behaviour by firms," the FSA review said.
"Most consumers, of course, have acted responsibly, but a significant minority have made decisions which were imprudent and which they should have been in a position to recognise as such in advance."
So the FSA has taken a step back and reviewed the UK's mortgage market and made suggestions aimed at preventing people getting in the same mess again.
What is the key proposal?
Under the plan, lenders would have to verify every borrower's income.
So a ban on self-certified mortgages, the type where lenders take the word of the borrower when they disclose their income, is prominent.
The FSA said that self-certified borrowers tended to take out larger loans and be more likely to fall behind on their repayments.
This type of mortgage was popular with self-employed people. These plans would mean lenders would have to go to these people's tax records to check how much they really earned.
This could be a problem for some self-employed borrowers, who might have overstated their income. When it comes to remortgaging, the lender might no longer agree to lend to them, or the borrower might be left to pay the standard variable rate.
Self-certified mortgages accounted for 49% of home loans being offered at the peak of the housing boom, but the market has dwindled as a result of the credit crunch. Only two lenders were offering these types of loans in August 2009.
I thought 100% mortgages and the like have been the problem?
There has been a lot of discussion about the opportunities open for borrowers in the boom to get a mortgage without offering a deposit, or to borrow a very high multiple of their income.
In this plan, the FSA has not said it will ban these high loan-to-value mortgages, but it has not ruled out new rules in the future if these initial proposals fail to have a "sufficient effect".
Instead, it wants to tell lenders that they will be responsible for assessing whether a borrower is able to pay.
"We propose to require all lenders to assess the level of a consumer's expenditure in determining the affordability of a mortgage product, to ensure that lending decisions are based on a consumer's free disposable income," the FSA said.
Lenders will be obliged to check what the would-be borrower tells them about their spending habits; they will not be allowed to take everything they are told at face value.
So long as lenders and borrowers do not conspire to get round this new approach, this might restrict the size of mortgages even more than the cruder methods of limiting a loan, in relation to either the value of the property (loan-to-value) or the borrower's gross income (loan-to-income).
What if I fall into arrears?
The FSA wants to make it much harder for you to be repossessed as its research has found that some lenders are moving far too quickly to take back properties.
It already has a list of steps that lenders can take to help those in arrears.
It now wants to make those measures compulsory for lenders, a such as steering people towards the various government schemes that have been devised to help borrowers in distress.
The FSA wants to stop lenders levying unfair administration charges on those who have had difficulty making repayments, but are now keeping to an arrangement to repay these arrears.
Five firms are already likely to face penalties for poor arrears and repossession handling, and for excessive arrears charges.
The proposals do not say that lenders will be prevented from repossessing a property if they fail to keep to these new rules.
Instead, a lender breaking the new rules on dealing with borrowers in arrears could face sanctions by the FSA which could include a fine or a demand to clean up their act.
Other matters for discussion include a possible limit on the amount of equity that can be withdrawn from somebody's home, and greater assessment of whether people taking interest-only mortgages can afford them.
What has the reaction been?
There has been a general view that this "discussion paper" has been well thought through, but some disagreement about who has been to blame for the problems of the past.
The Building Societies Association joined the British Bankers' Association in arguing that there should now be a "sensible balance" between regulation and opportunities for those who can afford it to get a loan.
The Intermediary Mortgage Lenders Association said that the FSA had made its own errors and it was being too simplistic in "heaping the blame" on non-bank lenders and self-certified mortgages.
The Council of Mortgage Lenders (CML) has accused some politicians of leaning more towards "rabble-rousing" than constructive arguments.
"We agree with the FSA that regulation in itself cannot resolve the problems of the recent market," said Michael Coogan, of the CML.
The FSA said that these proposals in themselves would not stop the boom and bust of the housing market.
What happens next?
The industry will get its chance to have its say on the proposals by the end of January 2010.
These comments will be outlined in a publication in March, followed shortly afterwards by concrete proposals and a timetable for implementation.