Mortgage Fraud in the Buy to Let Market
In recent years before the “Credit Crunch” the relaxation of lending criteria for those persons wishing to become property landlords meant that the number of people buying houses purely to rent out to students and professionals for income and capital speculation increased exponentially. No longer was there any requirement for such mortgages to be limited to multiples of the borrowers verifiable income. These loans were freely given on the simple basis that the anticipated rental income would cover the interest repayments by at least a specified margin.
Further protection for the lenders was supposedly obtained by the valuation of the property, and a willingness to lend only a proportion of this value to the prospective landlord. The latter was therefore forced to stump up typically 15% of the purchase price as a deposit thus providing a margin of safety for the lender should there be a need for the loan to be called. Given that property values were always believed to be on the increase – the lenders risk was extremely low. This of course was a bubble that had to burst.
Consider the situation where a taxi driver from Glasgow, of little means but who had previously never owed a penny to anybody, was made bankrupt as a result of buying four properties between 2002 and 2007. Her properties turned out to be worth substantially less than her mortgages and the rental income was insufficient to meet interest payments on the loans. Furthermore, she had run up £100,000 in debt in the form of loans taken out to try and meet the mortgage bills and her maintenance obligations on the properties.
By “gifting” the deposit to the buyer, the property developers were discounting their prices but are able to sell houses to people without incomes and without cash deposits purely on the basis that the rental income potential would cover the interest payments on what was effectively a 100% loan being taken out.
Indeed in 2008 I met one lucky customer whose day job earned him £30,000 per annum and who was persuaded by another property company to purchase 20 properties over a period of 6 months.
Lucky? All he had to do was wait 10 years and the property prices would have doubled making his portfolio worth around £10 million. Then he could sell the lot and pay off the £5 million he held in mortgages, the rental income servicing the loans in the intervening years.
You can imagine his horror when he eventually discovered that his properties were only worth £3 million and the rental income on the poor quality student lets fell far short of the glossy promises he had been given. He too is looking towards bankruptcy after struggling for 18 months or so trying to keep his head above water and hopefully obtain some redress from the developers.
These are extreme examples, but there are thousands of other hopeful landlords in similar situations around the UK. How can this have been allowed to happen? The starting point is the glitzy brochures offering the opportunity to become property millionaires. They told how it was possible to use borrowings to gear up investments and take advantage of a rising property market. This was common knowledge to the person with a shred of common sense.
However, the developers then packaged their properties, whether refurbished units, new build or even off plan investments, making the purchase extremely easy for the customer, who only has to sign the back of a mortgage application form. The mortgages were arranged in-house and the services of a friendly solicitor were used to convey the transactions on behalf of the customer. Thus for example a customer obtains a six bedroom property for £300,000. Although the customer will have paid perhaps a £2,000 reservation fee, the £45,000 deposit was gifted to him. He is left with a mortgage of £255,000 and the company has promised to manage the rental of the six bedrooms to local students. More than that, the developers have guaranteed the rental income from the property for one year.
Where does it all go wrong? The luckier customer will have 12 months of rental income flowing in. The unlucky one will have to fight for the regular payments and supplement the “guaranteed” income themselves while waiting for the developers to stump up the promised revenue. But even for the luckier ones, when the 12 months is over and the realisation of having to service a massive mortgage sets in, they begin to take an interest in the investment. The property is visited, often for the first time, to be found empty, devoid of tennants and in a poor state of repair. The customer will generally wonder what he has spent £300,000 on and will have his property valued by an independent surveyor. Now he will see that his property will be worth say between £150,000 and £200,000. He can’t sell it to cover the mortgage and he can’t keep it because the rental income is insufficient.
The developer has valued the property as a “business” estimating rental income of £65 per room per week and assigning a rate of return of say 6.5%. The rate of return is too low perhaps but who is to say what should be used. The room rate is high for a property in poor state situated too far from the university, but is a rate that some students will be paying elsewhere therefore seemed “feasible” at the time. One of the bedrooms in the property is a box room that can fit a single bed and nothing else. As a consequence it is impossible to let, but was one of the 6 bedrooms used to initially value the property none the less. In fact, the bricks and mortar valuation taken subsequently usually reflects the letting potential of the property much more accurately in practice.
So how can such a large mortgage be obtained? The mortgage lenders rely on the valuation being realistic and presume that the customer has shown his commitment by paying the 15% deposit. The mortgage form simply shows that £45,000 has been provided “from the applicant’s own funds”. Therefore in not disclosing the gifted deposit, the customer has committed a fraud on the lender.
But surely the customer’s solicitor would point this out? After all, they handle the deposit and lender’s principal on behalf of the customer for payment to the developer. Not at all, the solicitor is hardly independent, receiving hundreds of similar instructions each year referred to them by the developer. Indeed, they even take receipt of the gifted deposit from the developer, returning it to them with the balance of the transaction received from the lender, ostensibly to give the impression that the customer did own the deposit funds. The solicitor will say that they are receiving the deposit funds from the developer “who was holding them on behalf of the customer”, but in reality the customer is obtaining property that is overvalued even after being discounted by the deposit sum by obtaining a 100% mortgage from an apparently unsuspecting lender.
The response of the lenders is to sue the surveyors and solicitors for professional negligence and to repossess the undervalued properties from the defaulting customers. Many of these property developers come in similar variants of the same theme, and then they go leaving bankrupted individuals in their wake. Some are closed down by the Department of Trade and Industry (now the Department for Business Innovation and Skills) but some are the major construction companies – sailing close to the wind with their “buy to let” operation.
What was needed was tighter control over the ease with which individuals were able to obtain massive amounts of credit, a reflection perhaps of the credit mad society at the time. This has come too late for many with the squeeze of the “Credit Crunch”. Now a tangible deposit is required for such investment, with closer scrutiny by the lenders – sometimes as much as 45% or more! What amazes me is that the lenders are now being criticised for being too tight with their money.