New mortgage rules—a move in the right direction?

Following new mortgage rules introduced by the Financial Conduct Authority (FCA) last month, Graham Walters, partner within the banking and lending services group at TLT Solicitors, and Emily Benson, partner within the financial services regulatory team, also at TLT, discuss what the impact will be on the different parties affected.

Borrowers will have greater certainty about whether they can afford their mortgage in the event of future interest rate rises, as a result of changes to FCA rules which came into force on 26 April 2014. The changes are a result of the FCA’s mortgage market review (MMR) and will also mean most people will now get help from an adviser before taking out a mortgage.

What is the background to the new rules?

Graham Walters (GW): In the period up to 2008, mortgage lending criteria was very relaxed with high risk lending and borrowing going on. There was concern that failure to adequately assess affordability had caused severe hardship to some individuals in terms of the level of debts that they were carrying and for some, it resulted in repossession of their property.

The Financial Services Authority as it was back then, the FCA now, felt that a lot of poor practices had crept in to the mortgage lending market and so in 2009 they kicked off a full review of the market and after consultation with the industry final rules were published in October 2012. Those rules were implemented on 26 April 2014.

Who will it affect?

GW: The rules apply to the residential mortgage industry rather than commercial lending. Within the residential mortgage industry I think it affects everybody—lenders, intermediaries and ultimately the borrowers.

Lenders have really had to tighten up on their underwriting processes and they have an obligation now to ensure that loans are affordable. I think that is what has driven a lot of the press comment that we have seen over the last couple of weeks where they talk about the enquiries that lenders are going to make being very intrusive in terms of what people are spending their money on, around mortgage interviews being perhaps three hours long and around the fact that because the enquiries have to be made it is going to take much longer for the mortgages to be approved.

Certainly there is going to be a much more questioning approach. In assessing affordability lenders are going to be expected to take into account the expenditure that people are committed to making, for example loans for cars or furniture as well as basic household expenditure such as weekly shopping bills and any regular expenditure such as clothes or travel.

The other thing that lenders are going to be required to do is to stress test against those payments over the next five years in case there are any interest rate rises. While the FCA hasn’t specifically stated the amount by which they should stress test, it needs to be a minimum of a 1% increase in interest rates.

Also in terms of assessing affordability, in the period leading up to 2007 and 2008, interest only mortgages had become the prevailing mortgage type moving away from capital and repayment ones. One of the general concerns at the moment is that in the next 15 years there are a number of mortgages which are coming to the end of the term where there may not be a means of repayment in place. Going forward, lenders will be required to assess that affordability on a capital and interest basis unless there is a clearly understood and believable repayment vehicle in place. It will no longer be sufficient to say: ‘Oh, we’re just going to sell the property at the end of the term.’

For those that currently have an interest only mortgage the lenders are doing a significant amount around raising awareness to customers about the need to consider how they are going to repay the loan and they are encouraging them to move onto a capital repayment basis. The FCA has issued a completely separate paper on good and bad practice around how lenders should deal with interest only mortgages that are reaching maturity.

Also for borrowers coming to the term end who are wanting to get a new mortgage, perhaps because they don’t have a repayment vehicle in place, but who can’t comply with these new affordability requirements, there are provisions within the mortgage market review for lenders to be flexible with them as long as they are not looking to increase the amount which they have borrowed.

Emily Benson (EB): I agree. I would say that a lot of lenders are implementing exception processes for existing borrowers. I think they have some latitude from the FCA for existing borrowers (who are not looking to increase their borrowing but are seeking to port their mortgage to a new property) in the way that they take them through in to the new regime. In the short term the MMR will have the most impact on new borrowers.

GW: As an aside, regulation of second charge lending moved from the Office of Fair Trading to the FCA from 1 April 2014.

How has the MMR been implemented?

GW: From the original discussion paper in 2009 and the proposed package of reforms published in 2011 there have been various opportunities for individual lenders and the trade bodies (predominantly the Council of Mortgage Lenders and the Building Societies Association) to respond. Out of those responses the FCA made some changes and then they published the final paper in October 2012 giving lenders nearly 18 months to implement them.

Will the new rules make it harder to lend to applicants with a bad credit rating or expensive lifestyle expenditures?

I think it will make it harder to lend to them but I think that maybe the better question is will it make it harder for those people to borrow money (and in the amounts that they did) and yes it will.

The changes are trying to ensure that there is continued access to mortgages for the majority of people but providing that they can afford it. If you have a poor credit history or if you have a credit history which shows a lot of existing borrowing then it will be taken into account both in terms of calculating that affordability and also when stress testing the future payments.

If you have an expensive lifestyle your disposable income is going to be that much less and it will effectively limit what a lender is going to be able to lend.

It’s going to be difficult to get the funding to heed the old advice about stretching yourself as far as you possibly can to make sure that you get the biggest house that you can to avoid moving again soon.

It is going to be very interesting to see how it plays out.

Will the new rules affect the sale processes for intermediaries?

GW: Yes they will. For what is referred to as interactive sales, so where the sale is face-to-face or on the telephone, it removes, except in very limited circumstances, the non-advised sales process. The person taking the mortgage will now be receiving advice on the mortgage they are taking. To give that advice the individual will require the relevant FCA permissions and appropriate qualifications.

For intermediaries it means they need to have in place people with the appropriate qualifications, appropriate policies, procedures, systems and controls which will potentially add to their cost base.

What should lawyers advise their clients in light of the new rules coming into effect?

EB: Affordability has been taken away from the intermediaries and put with the lenders, so it’s not the lawyer’s role. It’s their role to ensure that legally speaking you get to buy what you intended to buy and regards the suitability and affordability of the mortgage the onus is on the lenders.

GW: I agree. What hasn’t changed under the MMR is if a solicitor comes into information which leads them to believe that the client has misled the lender they would need to get the agreement of the client to disclose that to the lender, but that has always been the case.

Where does this fit with other developments with the FCA?

EB: What’s interesting is that this comes at a time when the FCA is also tightening up the requirements in relation to unsecured credit. So we could see quite a dramatic pinch about to take place because if you can’t borrow enough to do what you want to do with your mortgage and then you go off to the credit consumer providers who are now applying the same affordability processes and coming back with the same answers then I think that will be frustrating for a lot of people. I think that over the next 12–18 months we might see some controversy about this.

Interviewed by Fran Benson.

The views expressed by our Legal Analysis interviewees are not necessarily those of the proprietor.