Would you lend £52,000 to Mr and Mrs Stevens?

Britannia – the sharing society

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 MembersÕ 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. This case study shows how Britannia makes its lending decisions based on
ensuring the reliability and creditworthiness of borrowers and that properties for
which mortgages are granted, are a sound and secure investment for house purchasers and for Britannia.

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?

This case study examines the mortgage lending process and the detailed set of considerations that must be taken into account before granting a mortgage. 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 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:

1. time-consuming and costly to administer
2. damaging to the public image of Britannia and building societies as a whole
3. examples of poor customer service.

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:
1. identity and present address of the applicant

2. marital status and children
3. income and employment
4. 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:
1. is over 18 years old at the date of completion
2. 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:
1. seasonally based employment, e.g. fruit picking or seaside casual work
2. commission-only salespeople, e.g. a computer salesperson whose
earnings are based entirely on the number of sales he/she makes
3. 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 applicantÕs 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:
1. hire purchase and bank loan repayments
2. credit card payments
3. maintenance payments (e.g. child maintenance)
4. 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’s 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
applicantÕs
information

Britannia now have sufficient information to feel confident in the Stevens’s 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:

1. voters/electoral information
2. 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 applicantÕs employer showing
the:
1. income of the applicant
2. regularity of any overtime, bonus or commission.

On the Stevens’s 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