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In recent years the relaxation of lending criteria for those persons wishing to become property landlords has meant that the  number of people buying houses purely to rent out to students and professionals alike has increased enormously.  No longer  was there any  requirement for such mortgages to be limited to multiples of the borrowers earning capacity.  These loans were  freely given on the simple basis that the anticipated rental income would cover the interest repayments by at least a  specified margin.

Further protection for the lenders was supposedly obtained by the formal valuation of the property, and a willingness to lend  only a proportion of this value to the prospective landlord.  The latter was therefore forced to stump up typically 15% of  the purchase price as a deposit thus providing a margin of safety for the lender should there be a need for the loan to be  called.

How did the situation arise then, where a taxi driver from Glasgow, of little means but who had previously never owed a penny  to anybody, was made bankrupt as a result of buying four properties between 2002 and 2007?  Her properties turned out to be  worth substantially less than her mortgages and the rental income was insufficient to meet interest payments.  What is more,  she had run up £100,000 in debt in the form of loans taken out to try and meet the mortgage bills.

By “gifting” the deposit to the customer, the property developers were discounting their prices but are able to sell houses  to people without incomes and without cash deposits purely on the basis that the rental income potential would cover the  interest payments on what was effectively a 100% loan being taken out.

Indeed in 2008 I met one lucky customer whose day job earned him £30,000 per annum and who was persuaded by another property  company to purchase 20 properties over a period of 6 months.

Lucky?  All he had to do was wait 10 years and the property prices would have doubled making his portfolio worth around £10  million.  Then he could sell the lot and pay off the £5 million he held in mortgages, the rental income servicing the loans  in the intervening years.

You can imagine his horror when he eventually discovered that his properties were only worth £3 million and the rental income  on the poor quality student lets fell far short of the glossy promises he had been given.  He too is looking towards  bankruptcy after struggling for 18 months or so trying to keep his head above water and hopefully obtain some redress from  the developers.

These are extreme examples, but there are thousands of other hopeful landlords in similar situations around the UK.  How can  this have been allowed to happen?  The starting point is the glitzy brochures offering the opportunity to become property  millionaires.

They told how it was possible to use borrowings to gear up investments and take advantage of a rising property market.  This  was common knowledge to the person with a shred of common sense.

However, the developers then packaged their properties, whether refurbished units, new build or even off plan investments,  making the purchase extremely easy for the customer, who only has to sign the back of a mortgage application form.  The  mortgages were arranged in-house and the services of a friendly solicitor were used to convey the transactions on behalf of  the customer.  Thus for example a customer obtains a six bedroom property for £300,000.  Although the customer will have paid  perhaps a £2,000 reservation fee, the £45,000 deposit was gifted to him.  He is left with a mortgage of £255,000 and the  company has promised to manage the rental of the six bedrooms to local students.  More than that, the developers have  guaranteed the rental income from the property for one year.

Where does it all go wrong?  The luckier customer will have 12 months of rental income flowing in.  The unlucky one will have  to fight for the regular payments and supplement the “guaranteed” income themselves while waiting for the developers to stump  up the promised revenue.  But even for the luckier ones, when the 12 months is over and the realisation of having to service  a massive mortgage sets in, they begin to take an interest in the investment.  The property is visited, often for the first  time, to be found empty, devoid of tennants and in a poor state of repair.  The customer will generally wonder what he has  spent £300,000 on and will have his property valued by an independent surveyor.  Now he will see that his property will be  worth say between £150,000 and £200,000.  He can’t sell it to cover the mortgage and he can’t keep it because the rental  income is insufficient.

The developer has valued the property as a “business” estimating rental income of £65 per room per week and assigning a rate  of return of say 6.5%.  The rate of return is too low perhaps but who is to say what should be used.  The room rate is high  for a property in poor state situated too far from the university, but is a rate that some students will be paying elsewhere  therefore seemed “feasible” at the time.  One of the bedrooms in the property is a box room that can fit a single bed and  nothing else.  As a consequence it is impossible to let, but was one of the 6 bedrooms used to initially value the property  none the less.  In fact, the bricks and mortar valuation taken subsequently usually reflects the letting potential of the  property much more accurately in practice.

So how can such a large mortgage be obtained?  The mortgage lenders rely on the valuation being realistic and presume that  the customer has shown his commitment by paying the 15% deposit.  The mortgage form simply shows that £45,000 has been  provided “from the applicant’s own funds”.  Therefore in not disclosing the gifted deposit, the customer has committed a  fraud on the lender.

But surely the customer’s solicitor would point this out?  After all, they handle the deposit and lenders principal on behalf  of the customer for payment to the developer.  Not at all, the solicitor is hardly independent, receiving hundreds of similar  instructions each year referred to them by the developer.  Indeed, they even take receipt of the gifted deposit from the  developer, returning it to them with the balance of the transaction received from the lender, ostensibly to give the  impression that the customer did own the deposit funds.  The solicitor will say that they are receiving the deposit funds  from the developer “who was holding them on behalf of the customer”, but in reality the customer is obtaining property that  is overvalued even after being discounted by the deposit sum by obtaining a 100% mortgage from an apparently unsuspecting  lender.

The response of the lenders is to sue the surveyors and solicitors for professional negligence and to repossess the  undervalued properties from the defaulting customers.  The particular property developer that I was investigating meanwhile  is investing its substantial profits from buy-to let into prime “business to business” city centre developments and  presenting a respectable veneer to the outside world.  Many of these property developers come in similar guises or variants  of the theme, and then they go leaving bankrupted individuals in their wake.  Some are closed down by the Department of Trade  and Industry (now the Department for Business Innovation and Skills – and some, like the developer in the example above, even  peak the interest of the Serious Fraud Office.  However what is needed is tighter control over the ease with which  individuals were able to obtain massive amounts of credit, a reflection perhaps of today’s society.  This has come too late  for many with the squeeze of the “credit crunch”.  Now a tangible deposit is required for such investment, with closer  scrutiny by the lenders – sometimes as much as 45% or more!