They are the lenders who are 'not afraid to go for the jugular', writes Caroline Madden

To aspiring homeowners whose mortgage applications have been crumpled up and thrown straight in the bin by mainstream banks, "sub-prime" mortgage lenders can seem like the answer to their prayers.

Willing to extend credit where other banks fear to tread, these "specialist" and "open-minded" lenders market themselves as a springboard for individuals who don't conform to traditional lenders' "cookie-cutter" criteria. However, are they really acting in the best interests of the consumer or are they tempting the vulnerable to overextend themselves financially?

The recent meltdown of the US sub-prime market has brought into sharp relief the dangers of pushing this high-risk model to its extreme. In the US, aggressive lending practices were adopted by banks chasing higher returns, and the sub-prime mortgage market grew exponentially. However, as interest rate rises kicked in and the housing market faltered, the default rate on mortgages in the US sub-prime market reached 14 per cent.

Of course compared to the US, the Irish market is still in its infancy. As recently as the start of 2005, there was only one player in the market - GE Money Mortgages - although other specialist lenders have recently piled in, tempted by the fat margins on offer.

In the US last year, one in five new mortgages was of the "non-conforming" variety, whereas just over 2 per cent of the total Irish mortgages market is classed as sub-prime. Nevertheless the market here is developing quickly and is expected to increase several fold as it matures.

A key feature of the US mortgage market is that it is driven by securitisations, with lenders preferring to sell on their mortgage books to investors and hedge funds rather than holding mortgages on their balance sheets.

The notion of securitisation first entered the Irish market in 1995, but it is only in recent years that is has become a mainline feature of the mortgage business.

Over the past year, the Irish mortgages market has seen a worrying surge in mortgage-backed securitisations, including in the sub-prime sector. Start Mortgages, which entered the Irish market in early 2005, for example, announced a €525 million securitisation in January.

The potential difficulty with securitisations is that they can reduce the incentive for the lender to ensure that the credit being extended is safe, as it essentially becomes someone else's problem when the debt is sold on.

From the borrower's point of view, securitised mortgages can also be considerably less flexible if individuals' circumstances change.

Also, although predatory lending products being pushed in the US (such as so-called liar loans, teaser loans and stretch loans) have not caught on here, some consumer protection issues could emerge as the market becomes more competitive.

A number of sub-prime lenders, such as Start Mortgages, GE Money's mortgage activities and Nua Homeloans, are not authorised by the Irish Financial Services Regulatory Authority.

This means that although they are bound by the Consumer Credit Act, they do not have to comply with the Consumer Protection Act. One of the most worrying aspects of this is that they do not have to establish that a product is suitable for the customer, not do they have to be able to demonstrate to the regulator why they sold a particular product to the customer.

Michael Culloty of the Money Advice and Budgeting Service (Mabs) is particularly concerned by the implications of this. "It is a ludicrous situation whereby you have a consumer protection code and the consumers who are most vulnerable are probably the least protected," he said.

"Wouldn't you think that a consumer code would have universal application?"

"Stay away as much as possible from [ sub-prime lenders]," he warns. He advises that consumers should view the sub-prime route only as a short-term means of improving their credit rating before switching as soon as possible to a cheaper mortgage.

It isn't all doom and gloom, though.

Michael Dowling of the Independent Mortgage Advisers Association (Imaf) says specialist lenders here facilitate many "near prime" customers, who have difficulty proving their income due to being self-employed etc, as opposed to having a tarnished credit history.

"It would seem from our information that those customers are not having any difficulty in servicing debt, because their issue wasn't in earning money, it was in verifying their income," he says.

Mr Dowling also points out that US borrowers face significantly higher interest rates. The base rate there is 5.25 per cent, compared to 3.25 per cent here.

In the US, margins of 10 to 15 percentage points above the base rates are not uncommon, whereas the most punitive rate charged in here on sub-prime mortgages is 9.25 per cent.

Although the Irish housing market is also undergoing a correction at the moment, Scott Rankin of Davy Stockbroker says the parallels between the Irish and US situations end there and he advises against jumping to conclusions that the Irish sub-prime market will follow the same path.

"There are great differences between the [ sub-prime] market here and the market there," he says. The Irish economy remains strong, he says, with a healthy savings ratio, robust growth in disposable incomes, and very low rates of credit card bad debt in comparison to the US.

However, as interest rates rises take their toll and some sub-prime mortgage holders with particularly poor credit histories are now facing interest rates of 9.25 per cent, is the strain beginning to show?

Mr Culloty has certainly noticed an increase in the number of people contacting Mabs who are struggling to meet their repayments to sub-prime lenders.

However Mr Rankin is confident that the spectre of an explosion of repossessions is not looming.

"You'd have to see something fundamentally change in the employment market, or indeed interest rates shooting for 5 per cent pretty quickly, before you'd change that view."

Mr Dowling says that it's early days yet, but he has noticed that sub-prime lenders are very much "on their toes" in terms of keeping a close eye on repayments and are much more proactive in dealing with an arrears situation. Mr Culloty says sub-prime lenders tend to "go for the jugular" more quickly.

With the sub-prime market becoming an increasingly crowded space, with more and more players chasing a growing but still small amount of business, it will be interesting to see whether lenders will compete by dropping their prices or their lending standards.