In order to understand what happened when the credit crunch of 2007/08 occurred, it helps to look back at what happened in the years leading up to it.
Winding the clock right back to the 1970’s and 80’s, if you took out a first time buyer mortgage to buy a home it was probably through your local building society. Believe it or not, there was a time that banks didn’t actually do mortgages.
To qualify for a mortgage, you would make an appointment with the local building society manager to see if you would qualify or not. The money they had to lend was the money they held on account from customers who had savings accounts with the society. They would charge a higher rate of interest to borrowers than the rate they were paying to savers in order to make a profit.
When banks started to get involved in mortgage lending they moved away from this old model. Instead, they would “buy” the money from the markets to lend out and this accelerated the rate at which they could lend.
Roll forward to the mid-2000’s and a whole new set of Specialist Lenders were operating in the market, most of them having started in the USA. They would lend to a set of customers and then “sell” their book of mortgage customers on in order to raise new money to lend again.
The process of selling the book on was called securitisation. The investors that bought these “books” tended to be large financial institutions such as pension funds and yes, you guessed it, high street banks.
The market became lucrative and this new set of Lenders introduced more relaxed lending criteria. They were lending to customers with poor credit histories and allowing them to self-certify their incomes without checks.
These mortgages began to default, and major banks lost confidence in each other because they could not be sure how exposed they were in the sub-prime mortgage market which was unraveling.
Banks’ share prices plummeted, and some were bailed out by the UK Government (UK taxpayer!) to stop them going bust.
As a result, lending dried up, property prices went down and everyone lost confidence in the economy. It took more than 5-10 years for the market to recover.
No one wanted this situation to reoccur, especially the Government so investigations were instigated to look into where it all went wrong.
The result of the studies led to the Mortgage Market Review of 2014. Self-cert mortgages had already been banned by then, but the major change was that Lenders had to take responsibility to ensure their mortgages were affordable.
They introduced more stringent rules and dug much deeper into customer’s incomes and also outgoing as. Lenders started to pay much more attention to how much people were paying out on credit commitments, childcare and other regular outgoings to ensure mortgages remained affordable.
It is obviously significantly harder to get a mortgage now than it was back then. Customers have to be much more organised with their paperwork and ensure they can prove to a bank that they take their finances seriously.
Lots of mistakes were made in the period running up to the credit crunch but hopefully the industry learned its lessons to minimise the chances of something like that occurring again.