Sub-prime mortgage lenders in the UK could be heading the same way as their troubled US counterparts unless they change their lending practices, the City Watchdog gave warning last week.

Speaking at the Council of Mortgage Lenders (CML) annual lunch on Friday, Clive Briault, Managing Director of Retail Markets at the Financial Services Authority (FSA), said: “I accept that the UK sub-prime market is not the same as in the US...However, we cannot completely ignore the parallels with our own market.”

His comments came as it emerged that WMC Mortgage, the US sub-prime lender owned by General Electric, plans to lay off 771 workers, around half of its workforce.

US sub-prime lenders have been hit by soaring numbers of late payments and home repossessions. Many US borrowers were unable to meet their repayments when the initial low rates on their home loan soared after the introductory period ended. But lenders in the UK do not sell this type of loan.

The £15 billion sub-prime mortgage market accounts between 5 and 6 per cent of the market, according to figures from the CML.

Mr Briault said that the level of debt being accumulated by some sub-prime customers could leave them, and lenders, in trouble if house prices start to fall.

“For example, lenders are in some cases taking on substantial risks through a combination of high loan to value ratios and high income ratios, in part because borrowers are using additional borrowing against the property as a means not only of debt consolidation but also of increasing their debt at regular intervals by taking as much advantage as possible of rising house prices.”

“Continued house price appreciation may therefore be masking some severe difficulties in some sectors of the housing market.”

Sub-prime lenders cater for homebuyers who have a chequered credit history, for example discharged bankrupts or those who have county court judgements (CCJs) lodged against them. The rates on sub-prime mortgages are often more expensive than mainstream mortgages. For example, a borrower who has 3 CCJs for a maximum of £5,000 would have to pay up to 6.3 per cent on a three year fixed-rate mortgage of £150,000, compared to the best-buy three year deal pegged at 4.89 per cent.

The FSA announced it was investigating the sub-prime mortgage market earlier this month, and Mr Briault said the findings would be published in June.

Sue Anderson, of the CML, said: “It is obviously right for the regulator to flag up risk, but our analysis of the market does leave us reassured that the structure of the our market is quite different from that in the US. The timing of the problems in the US also means that we have had good warning of what the potential problems could be.”

Mr Briault also fired a warning shot across the bows of mortgage lenders who have recently entered the subprime market. “The risks are particularly high where firms have no initial knowledge or experience in this specialised end of the market and are attracted mainly by the potentially wider margins available. We have seem cases where...it was far from clear to us how the senior management or the board of the firm could have taken a fully informed decision to enter the sub-prime market.”

Several lenders have entered the sub-prime mortgage market in the last 18 months, including Alliance & Leicester, Northern Rock, DB mortgages - backed by Deutsche Bank, Mortgages Plc - backed by Merrill Lynch and SPML, Preferred mortgages and LMC which are all backed by Lehman Bros.

Ian Giles, of Kensington Mortgages, a leading sub-prime lender, said: “The FSA is there to make sure consumers are best served. But we certainly don’t see any connection between the US meltdown and the UK sub-prime market. Borrowers in the US are more indebted than in the UK, the adverse mortgage market grew massively because lenders relaxed their lending criteria in the US, which UK lenders haven’t done, and interest rates in the UK are unlikely to rise as quickly as they have in the US.”