Cheap credit has fuelled debt fears

The City watchdog is urging mortgage lenders to be more cautious when assessing consumers for a home loan, given concern over rising consumer debt.

The Financial Services Authority said that it was important for lenders to carry out a "sanity check" on the information supplied by applicants.

Philip Robinson, an FSA director, told mortgage professionals that if people continued to borrow at such a rate they would be "unpleasant financial consequences further down the line".

The Citizens Advice Bureaux recently reported that incidences of problem debt had risen by 50% over the last five years, with one in five people who have credit using it to cover everyday household bills.

Sanity check

The current economic climate of record employment and low interest rates have fuelled a credit boom.

But it now means that levels of household debt are higher than they were in the late 1980s - and there is increasing concern about people's ability to repay when economic conditions change.

Mr Robinson said that while there was not yet a problem with mortgage arrears, recent figures which showed a sharp increase in personal bankruptcies - the highest level since 1993 - was a "clear indicator that not all is well."

The FSA is warning lenders to make sure lenders take account of not just credit commitments but also lifestyle events, such as divorce.

"For example, given the current divorce rate and trend, family support payments must be a significant figure for a number of borrowers," Mr Robinson said.

Stress test

Lenders should perform a "sanity check" on the information given, to determine there are no anomalies in the figures supplied by loan applicants.

There should also be a "stress test" for all new borrowers against the potentially higher borrowing rates that might occur during the first few years of the mortgage.

"A 2% increase in the current level of base rates could translate into a near 50% instalment increase for a number of variable rate, interest-only mortgage borrowers.

"For people who have already fully borrowed this could be financial disaster," the FSA said.

Factors such as the increases in National Insurance and Council Tax should also be factored into assessments of someone's ability to repay a loan, the FSA added.