Britannia is the third largest UK building society, with group assets exceeding £16 billion. Following the conversion to plc status of a number of building societies, Britannia has emerged as one of the leading advocates of retaining its mutual status. In support of this stance, Britannia announced a unique Members’ Loyalty Bonus Scheme in February 1996. In early 1997, therefore, a million members shared £35 million of the profits through an annual cash payout. Britannia can truly be called ‘The Sharing Society.’
The business mission of Britannia is:
‘To improve the financial health of our members and customers by satisfying their evolving borrowing, investment and housing needs.’
This case study outlines key aspects of how this mission operates in practice. The purpose of Britannia, like other building societies, is to raise funds from households looking for safe and prosperous savings opportunities, and lend these funds to borrowers to help them buy their homes with a mortgage of 20 to 30 years.
The mortgage market is one of the most important sources of investment to the UK economy. Every year thousands of new borrowers take out mortgages with building societies and other financial institutions. This enables them to purchase, over a period of time, the most important asset they will ever own - a home. Some borrowers will be first time buyers. Others will be onto their second or third homes, or even their final retirement homes.
In essence, a building society provides a simple means for households to save for the future or deposit any spare funds (savings) and for borrowers to arrange to raise the necessary finance to purchase a house through a long term mortgage (usually for 20-25 years). Britannia safeguards the savings of its depositors, while paying them interest and lends out these savings to customers wishing to take out a mortgage to buy a property. The customer taking out the mortgage pays interest to the Britannia.
The Britannia therefore acts as custodian to vast sums of money which have been entrusted to it by savers. It must also ensure that its lending decisions are based on sound financial judgements. Britannia needs to make many decisions in the nature of ‘Should we lend £52,000 to Mr and Mrs Stevens.’ As a responsible lender, Britannia is interested in their ability to take on such a financial commitment and the risk associated with it. For example, do Mr and Mrs Stevens have steady incomes? Are they likely to be employed for a number of years? Is the property that they hope to buy worth the price they are paying for it?
What has to be known about an individual prior to granting a loan?
Whenever the Britannia receives an application for a mortgage advance, it must make sure that the applicant will be likely to fulfil the promise contained in the final mortgage deed:
‘to repay the mortgage by the proper instalments.’ For the Britannia, this means working out whether the customer can afford the repayments, and whether they are likely to do so. It would be wrong to lend to a customer if they might not be able to repay the loan.
When an individual takes out a mortgage, the usual procedure is to put down a deposit of 5% of the value of the house. The Building Society then advances the remainder of the sum required to purchase the property. The borrower repays the Building Society in instalments (plus interest) over a period of time. Britannia usually lend up to 95% of the purchase price or the valuation (by an independent valuer), whichever is the lower.
The usual way of calculating how much Britannia will lend is to look at the income of the borrower. Britannia will lend up to 3 x the higher income plus 1 x the lower income, or they can borrow 2.5 x the joint income, whichever is greater. For example, Jane Stevens earns £13,000 a year as a school secretary. Her husband, Philip, earns £8,000 a year as a cleaner for a large company.
Assessing the borrower
Britannia needs to take a number of other factors into account when assessing a borrower. If inadequate attention is paid to the assessment process, it will result in more people defaulting on repayments, causing arrears and ultimately repossession.
Arrears and repossessions are:
- time consuming and costly to administer
- damaging to the public image of Britannia and building societies as a whole
- examples of poor customer services. They also lead to losses, which reduces the amount of interest Britannia can pay to its investors.
The application form
The application form provides the largest single body of information about the applicant. It is completed and signed by the applicant and provides the following information:
- identity and present address of the applicant
- marital status and children
- income and employment
- details of existing mortgage (or rent).
The status of the borrower
The Britannia needs to establish the status of the potential borrower. The most basic requirements are that the applicant:
- is over 18 years old at the date of completion
- has a regular income from an acceptable category of employment
Where the loan required exceeds 75% of the valuation or purchase price (whichever is the lower), known as the Loan To Value (LTV), the following categories of employment will not be acceptable to Britannia:
- seasonally based employment, e.g. fruit picking or seaside casual work
- commission only sales people, e.g. a computer sales person whose earnings are based entirely on the number of sales he / she makes
- any employment where over 50% of payment is commission.
Also, where an applicant has recently started their career, (e.g. first job, or returning to work following a career break) they must work a minimum of 6 months before their income can be taken into account. The Stevens certainly meet all the requirements outlined above. They are in their early 20's and have had regular employment for the last three years. Neither rely on commission or seasonal work.
Once the applicant has satisfied the above criteria, Britannia needs to establish the applicant’s status and decide how much the applicant can borrow. Building Societies use the term ‘status’ as a measure of whether the applicant can reasonably afford the monthly repayments on the loan they have applied for. To establish the status of applicants, it is important to look at both their income and any regular outgoings which must be taken into account. For example, a borrower may be trying to secure a second mortgage, or purchasing an expensive item (e.g. a car) on hire purchase.
Income and outgoings
When assessing the income of an applicant Britannia will count their gross annual salary (i.e. before tax and other deductions) plus 100% of their guaranteed bonuses and overtime pay. When Britannia is dealing with a self-employed applicant they will count net profit as income. This will be taken from end of year accounts providing profits have been increasing over a 3 year period. In assessing regular outgoings Britannia will include:
- hire purchase and bank loan repayments
- credit card payments
- maintenance payments (e.g. child maintenance)
- bank charges for an overdraft.
When calculating the applicant’s status, the total outgoings are subtracted from the total income. Building societies are primarily concerned with the disposable income of the household when determining whether to lend money and how much is appropriate to lend. Fortunately, Britannia find that Mr and Mrs Stevens’ outgoings are well under control. They do have a credit card but pay any outstanding balances at the end of each month. They have outstanding hire purchase for their car which has eighteen instalments of £105 per month left to pay.
Verifying the applicant’s information
Britannia now have sufficient information to feel confident in the Stevens’ financial status. However, it will not proceed with the application until further checks have been made by outside impartial sources.
All building societies today carry out a number of enquiries. The most important of these is to make a credit reference enquiry on every address the applicants have lived at over the last 3 years. The credit reference agency obtains:
- voters/electoral information
- credit information.
This information enables Britannia to confirm the identity and creditworthiness of the applicant. It may reveal that potential borrowers have failed to pay back debts in the recent past, or that they failed to disclose some of the current repayments of money borrowed elsewhere. The search also shows if an applicant has a recent record of bankruptcy. Credit referencing provides reliable and impartial information to give a supporting profile of the applicant. Britannia will also request information from the applicant’s employer showing the:
- income of the applicant
- regularity of any overtime, bonus or commission.
On the Stevens’ application form, Jane had declared that her gross income per month was just over £1,050. When Britannia checked this information with her employer, they found that Jane had just been given a rise so that her new monthly salary was £1,080. They were, therefore, more than happy with the details she had provided.
Britannia requires a satisfactory Employer’s reference from all applicants. Britannia writes off for this information rather than simply accepting evidence provided by an applicant. Britannia uses all this information to ‘credit score’ the applicant.
Credit scoring is a technique used by many lenders to assess credit worthiness. It is a proven statistical technique which allows Britannia to calculate and predict the likelihood of non payment of a debt. Although most lenders use credit scoring, they each have a different score card, because they have different lending policies and experience.
Britannia’s credit score works by giving points, which are allocated based on the answers given on the application form and on personal information provided by the credit reference agency. The decision is then taken, based on whether or not the applicant passes a certain score. The system does not discriminate against race, sex or geographical area, and is considered by the Government to be an aid to promoting and safeguarding consumers’ interests.
Assessing the property
The assessment of the applicant is only one side of the equation when deciding whether to grant a mortgage. The other side involves assessing the property. The security provided by the property is an insurance against the risk of default by the customer, as it can be repossessed and sold to repay the loan. When a building society considers any mortgage application, a vital concern is to ensure the property to be mortgaged offers sufficient security for the loan.
Before making an assessment of a property, it is necessary to clarify the types of tenancy and property a building society will normally lend on.
These fall into the following areas:
- tenure - is the property freehold (i.e. owned absolutely by the borrowers when the mortgage is repaid) or leasehold (i.e. owned by the occupiers for a fixed number of years, - a lease)
- acceptable and unacceptable properties - Britannia will not lend on mobile homes or houseboats
- suitable construction materials.
Britannia is usually prepared to lend only where the property is:
- built with traditional brick or stone
- timber framed with a suitable guarantee, with the whole of the outer skin being built in brick.
The Stevens wanted to buy a brick built house on a freehold house over a 25 year period. Britannia was happy with this arrangement and set out to value the property.
Building societies always arrange a valuation of every property on which a new advance is made. Both borrowers and lenders want to be assured that the value matches up to the purchase price and there are no defects which could affect the property’ marketability and value. A valuation report provides concise information on the state of repair and condition of the property. It is important to realise that there are different levels of report, depending on how much time and effort the valuer is asked to put into examining the property. The more detailed the report, the more expensive it will be to undertake. These valuations must be done by qualified surveyors.
Where properties are overpriced then the purpose of the valuation will be to put a true value on the property. The buyer may still want to proceed with the purchase but will find that the Building Society will only provide up to 95% of what it considers to be the real value of the property. In some cases, for example, when a property is suffering from severe subsidence, then the building society may not be prepared to advance any mortgage at all.
The Stevens house was in an excellent location and passed all the valuer’s detailed checks. They had £8,000 to put down as a deposit on the £60,000 house of their choice. The independent valuer employed by Britannia valued the house at £60-65,000 and found it to be in excellent condition.
Britannia was delighted with the valuer’s report. A mortgage offer was sent the Stevens including details of the loan the society was prepared to provide. Simultaneously, it sent formal instructions to the Stevens solicitor who was able to proceed with the purchase of the house.
Britannia was also able to provide the Stevens with a range of suitable insurance policies including buildings and contents insurance and unemployment, accident and sickness protection, in case work difficulties or illness ever jeopardised their mortgage repayments.
The Stevens case exemplifies the story of the thousands of people every year who buy their new home with a mortgage from Britannia. It highlights how Britannia takes precautions to ensure that its business is carried out in a safe and secure way. This serves to gain the confidence of Britannia’s lenders and borrowers as well as that of other organisations and individuals who deal with Britannia.