Friday, 21 January 2011

A classic case of Northern Crock

Someone I know has to sort out the estate of a friend of his who died last week, the poor fellow had cancer and was only 35. He has been making enquiries into his friend's assets and liabilities. Apart from a few hundred in the bank and normal household effects the only major asset is an ex-council flat originally bought some years ago under the right-to-buy legislation, the deceased bought it four years ago for £170,000 with the assistance of a loan from Northern Rock. It is a classic example of why Northern Rock is known as Northern Crock.

The deceased was a hairdresser earning around £30,000 a year gross in 2007. He had been renting all his adult life and wanted to buy his own home but had very limited savings, so he searched for a 100% mortgage. Northern Rock advanced not only the £170,000 needed to buy the flat but also a £10,000 unsecured loan. The mortgage was repayable over 20 years but no mechanism was put in place to repay any of the capital and the borrower was not required to take out any life assurance to provide Northern Rock with a lump-sum in the event of his death. All that is pretty sloppy, they lent £10,000 more than the property was worth, a sum equivalent to about six-time the borrower's gross income, to someone who would have no obvious means of repaying the capital at the end of the loan period. Their only security was the property itself, and that is where the whole thing becomes a true crock.

Because the flat had originally been bought from the council some years before, the lease had only 57 years to run. These days leaseholders have certain rights to extend the period of their lease but it costs money and only happens if the leaseholder gets round to asking for it. In the meantime the property is worth only what it can be sold for in the open market. Flats with less than 60 years left on the lease are not accepted as security by most mortgage lenders (Northern Rock was one of the few foolish enough to lend against such a property), although an extension can be obtained it must be paid for and when the lease is running short it can cost many tens of thousands of pounds plus conveyancing costs and valuation costs if the freeholder does not agree the figure - all these costs must be borne by the leaseholder. In the case I am discussing the lease now has only 53 years to run and I would estimate the cost of gaining an extension to be between £20,000 and £30,000 (I claim no expertise, but that is my best estimate). This affects the current value of the property enormously because it excludes the vast majority of the potential market from being able to buy the flat. Only cash buyers are in the market and they are unlikely to buy an ex-council flat for their own occupation; the real market is professional landlords looking to extend their portfolio. They will only buy through an estate agent if they can get a real bargain, otherwise their money will go further by buying at auction. The reality in such a situation is that the open market value is the forced-sale auction value. In this particular case the open market value of the property on a long lease of 90 years or more is around £190,000-£200,000. As it is, anything in excess of £120,000 would be a good price for the vendor, it wouldn't be at all surprising to find the flat sells for no more than £100,000.

His executor will sell his household possessions for a few hundred pounds to off-set funeral expenses and, if he is sensible, will simply surrender the flat to Northern Rock - there is no point him engaging estate agents to sell because he would have to pay their fees himself. Northern Rock will recover a flat worth at most £120,000 to cover a secured loan of £170,000 and an unsecured loan of £10,000. Their loss is likely to be at least £60,000 - no less than one third of the total amount they advanced.

One might think they could have protected themselves through insurance. I do not know whether any part of the loan was insured against default but the life of the borrower was not. Had they insured part of the loan itself (using what is usually called mortgage indemnity insurance) they might be able to recover 10 or 15% of the secured loan but their loss will still exceed £30,000.

Although this is just one example, it illustrates the folly of the sort of high loan-to-value mortgage loans for which Northern Rock was famed. No one knows how many similar bits of trash sit on their books.


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Barnacle Bill said...

Glad to see you back again Mr. FB and a Happy New Year to you as well.

Regarding Northern Crock, I would still be interested in knowing how many NuLabor MPs had mortgages with it when it went feet up?
I've always had the suspicion there was more to the whole Northern Crock saga than we tax payers were ever informed of when it got bailed out.

john miller said...

Good to have you back.

I said at the time that Northen Crock should be left to rot, with just the normal indemnities protecting savers. Really, if you put your whole investment egg into one basket case you deserve what you get.

As it is, this little building society proved an irresistable template for the political class. It had been saved by politicians! So as a man, they all leaped to the aid of their wobbly banks hoping to look like men in shining armour. and now, typically for politicians, they moan that their stupidity has been taken advantage of.

An exapmle of the malaise that affected the banks is the attitude of Andy Hornsby, CEO of HBOS. Totally ignorant of banking and banking practice, he oversaw the production of a huge glossy lifestyle magazine given to every one of the thousands of employees. Full of invaluable advice on how to be a good little HBOS teamperson, this covered the whole PC health and lifestyle gamut, from 5 a day fruit and veggies, to bike riding to work, to abstaining from drinking alcohol from Sunday to Friday.

Bugger all help to anyone but hugely expensive to create. Sound familiar?

penlan said...

I'm fairly sure that mortgage indemnity insurance was not used by Northern Rock.Insurance companies caught such a cold on them after the crash of the early 90's that those policies have become very rare birds indeed.

The premiums required for the Rock's Bumper Book of Dodgy Loans would have been astronomical.

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There should have a better explanation on the loans with regards to your problems. There should have a fair treatment on all the clients, so that they will be able to trust the company. I am in doubt to those who were given proper perspective.

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