Topic 10 - Assessing the applicant’s financial status (UNIT 3) Flashcards
Who is ultimately responsible for the accuracy of the details submitted in the lenders application form when applying for a mortgage?
The applicant
Even in a situation when a mortgage adviser completes the form, the applicant must check it carefully for accuracy as it is their ultimate responsibility
The Proceeds of Crime Act 2002 and other money laundering regulation specify lenders are required to obtain at least 2 bits of information about a customers living situation. What are they?
The applicant’s address history of atleast the last 3 years; if it has changed in the last three years, a
previous address may also be required.
The lender must also find out the
basis on which the applicant is living in their current property – are they renting or living with parents, or mortgaged, for example
Many lenders specify that mortgage
business can only be accepted on normal terms if the borrower is resident
in the UK. Why is this?
For control purposes – in the event of mortgage loss it
can be difficult to sue a non‑resident.
Most lenders will consider loans to
non‑residents but with specific conditions attached
What key info does the lender need to know about in relation to the mortgage loan the borrower requires?
Advance required, and % of the purchase price
this represent (loan to value)
Deposit available
Repayment method
Buildings and contents insurance requirements
Other insurance requirements
How do mortgage lenders corroborate income from self-employment?
NOTE: Corroborate just means to provide evidence or support for whatever it is being corroborated
There are 3 ways
HRMC tax calculations from the last 3 years shown on the individuals self assessments
OR
Accountant’s Certificates confirming the businesses income over the last 3 years ( lenders will usually require the accountant to be a member of a
professional body and hold specified qualifications )
OR
Full business accounts for the past three years
What is a profit and loss account?
It is a record of the business income and expenditure for the trading year
Shows figures for gross profit and net profit for that year
What is a balance sheet?
How does this differ to a profit and loss account?
A balance sheet is a statement of the business’s assets and liabilities at the end of the trading year on one particular day
The profit and loss account covers the whole trading year
What is a the capital account?
A businesses capital accounts contains the following:
what remains of any capital that was used to establish the
business;
Any further capital injected into the business since it was
established;
Any surplus profits from previous trading years
A figure for personal drawings: the amount
withdrawn from the business during the trading year ( a lender should proceed with caution where the personal drawings figure exceeds the businesses net profit as it could indicate the applicant is living beyond their means (spending more than what can be afforded) because they are taking more out of the business than it is earning )
FLASHCARD 1/2
Directors of public companies are treated as employees for mortgage application purposes.
Where a director of a smaller company owns more than a set percentage of the business shares (20–25% is common), they are
likely to be treated in the same way as a self‑employed applicant
As shareholders they own the company, can control how much they are paid and can decide how profitsare distributed.
**
Despite this, they can be (but don’t have to be) ‘employees’
and will receive the same pay documentation as any other employee, such as a payslip and a P60
What is the key difference between a sole traders earnings and a directors earnings?
One key difference between a sole trader and a director is that a sole trader pays income tax at their highest marginal rates on net profits, regardless of whether they take the money or leave it in the business.
A company, on the other hand, pays corporation tax on profits after salaries have been paid to
employees (directors)
FLASHCARD 2/2
read flashcard 1/2…
how do many directors arrange their pay because of this?
Many directors arrange their pay so that they receive a small salary, typically just under the limit where they would have to pay National Insurance or income tax, and take a larger amount by way of dividends, typically paid quarterly
(NOTE: if dividends are paid monthly HMRC is likely to regard them
as ‘disguised salary’ and subject to tax and NIC in the normal way
Because of how directors arrange their income, it can be more erratic than that of a regular employee and their low basic salary could cause problems substantiating a mortgage
What three things comprise a directors pay?
Salary
(if they are
employed)
Dividends
Director loan’s
What is a ‘close company’
What is a ‘participant’ in relation to a ‘close company’?
If you are classed as a shareholder of a ‘close company’ what different things could this mean?
Close company = A company owned by five or less participants or by any number of participants if they are all directors (Family of a participator are also regarded as participators)
Participant = Any individual who holds an ownership stake in a close company, either as a shareholder, director or investor
Shareholders of close companies are anyone who has rights to acquire shares, anyone who has provided loans to the company that are still outstanding (but not trade creditors) or anyone who has rights to, or the right to acquire, distributions from the company.
What is a directors capital account?
Shows both the money the company is owed from participators and owes to participators
Includes several things such as any capital injected by directors to start the company, unpaid wages, the cost of business items supplied personally by a director, as well as straightforward loans between the company and directors
What is a directors loan account?
If a directors loan account shows the director is in high credit, what does this mean, what would a lender think of this?
Why is a directors loan account important in relation to mortgage applications?
Directors can lend money or borrow money to/from their close company. The director’s loan account records this
The directors loan account has two parts:
When the director is in credit (the company owes them money)
When the director is in debit (they have borrowed from the company)
If a directors loan account is in high credit it means the director has lent more money to to company than they have withdrawn. The benefit of this, is the director can withdraw any of the balance whenever they want TAX FREE.
Lenders love a directors loan account having high credit balance
Lenders will look at the director’s loan account when underwriting a mortgage application because it helps the lender to assess the company’s financial position
Can equity in a property be used as part of the affordability assessment for a mortgage application?
Equity in the property (loan to value) cannot be used as part of the affordability assessment, although it may form part of the overall mortgage assessment
How long does a lender need to retain the records of a mortgage application AND why?
The term of the mortgage
To be and show it is a responsible lender?
If a borrower wants to change the terms of their mortgage with their existing lender does the lender need to carry out a full affordability assessment again?
No they do not as long as they only varying the terms (ie, not remortgaging) and the following 2 things are satisfied:
the level of borrowing does not increase the amount outstanding on the mortgage, other than covering fees for the new arrangement.
there is no change to the terms of the contract that is likely to affect affordability
What is a ‘mortgage prisoner’
People who are unable to remortgage to a better deal, even when they are not borrowing more money
Most of the time this happens because their existing lender has become inactive meaning they are not offering any new mortgages, and they don’t meet the affordability requirements for other lenders
Briefly tell me the changes the FCA introduced in 2019 in relation to mortgage prisoners?
The FCA introduced less strict rules around customers looking to remortgage with the same or a different lender with no additional borrowing (ie consolidate debts)
It basically made affordability assessments less strict in the above circumstance so people dont end up being a mortgage prisoner
In 2019, the FCA introduced less strict rules around affordability requirements for customers wanting to remortgage with the same or a different lender with no additional borrowing
Tell me about the new rules introduced
The borrower must have an existing regulated mortgage with the lender
and must want to replace the mortgage with a new regulated mortgage on the same property
There must not have been a payment shortfall at the time of the application
or in the previous 12 months
The rules apply where the new arrangement will be more affordable ONLY.
The lender can choose whether to implement the new process, or not, but if it opts for the adapted rules it must apply the same rules to all borrowers
in the same circumstances. It cannot apply the rules to some borrowers and not others when it suits…
The new arrangement can be of a different type, eg different interest rate,
fixed, interest‑only to repayment. (NOT repayment to interest‑only!!!!)
The new mortgage cannot exceed the outstanding amount of the existing
mortgage, other than to finance related mortgage and adviser fees
What is an individuals free disposable income?
disposable income – the amount of cash left after tax, National Insurance and normal expenses have been deducted
It is important for lenders to establish this when assessing affordability
The process,
known as an interest rate ‘stress test’ was introduced in 2014
Tell me about this
Mortgage Lenders must assess the impact of potential interest rate increases on the borrower’s ability to maintain mortgage payments in the future, known as the interest rate stress test
Potential increases are based on the interest rate in place at the start of the mortgage and the effect an increase in the Bank of England (BoE) base rate
would have on the lender’s rate
The interest rate ‘stress test’ was introduced in 2014 which mortgage lenders must follow
When carrying out a stress test, what must the lender do if the mortgage rate will increase to the lender’s standard variable rate (or another rate) during the term?
The stress test must use the SVR in place when the mortgage starts when applying the interest rate stress test.
NOTE. SVR = reversion rate
What is a standard variable rate?
What is it otherwise known as ?
The standard variable rate is the default interest rate set by a lender on a certain products such as loans or mortgages. It is known as the lenders reversion rate.
It is often higher than the introductory rate for that product
For example, a mortgage lender offers a variable mortgage at 5% which will remain so for 2 years. At the end of the 2 years it will change to the lenders SVR which is currently 6% ( but this can obvs change )
What is a lenders reversion rate?
It is the lenders standard variable rate (the default interest rate set by a lender on a certain products such as mortgages or loans)
The interest rate ‘stress test’ was introduced in 2014 which mortgage lenders must follow to assess affordability
The lender must consider potential interest rate increases over a minimum
period of how many years?
How does the lender decide the interest rate they are going to set for the stress test?
What is the minimum interest rate that must be set for stress tests
5 or more years
When deciding on the interest rate to use for the stress test, the lender must use an independent and recognised source of information.
The minimum limit that must be tested is 1% so if the guidance says the rates will increase to less than 1% it still must be set at 1%. Obvs if the guidance says the rate will be higher, you test it to that level
The PRA established a ‘loan to income flow limit’ in 2014
Why was it introduced and how does it work?
It was introduced to prevent a high number of households becoming overburdened with mortgage debt
Lenders can have a max of 15% of their residential mortgages with borrowers who have income less than 4.5x their total mortgage
NOTE: This only applies new first charge mortgages, including remortgages
where there is additional borrowing
What is a ‘credit impaired customer?
Someone who within the last two years has owed the equivalent of three months’ payments on a mortgage or other loan
Someone who within the last three years has had one or more county court judgments, totalling more than £500
Someone who has had an individual voluntary arrangement or bankruptcy
order in force within the last three years
