Mortgage Lending in the post MMR world

Speech by Linda Woodall, Director of Mortgage and Consumer Lending, Council of Mortgage Lenders Conference, London. This is the text of the speech as drafted, which may differ from the delivered version.

Today I would like to talk about what life looks and feels like post the Mortgage Market Review (MMR). I would also to outline our next steps in terms of thematic work and say a bit about what we see as the future challenges facing the industry.

This time last year I spoke to you about the new FCA approach to supervision as a conduct-only regulator and set out our expectations of firms.  It’s fair to say that since then we have seen a sea-change in the attention being paid to the conduct agenda across the financial services sector. Two or three years ago, conduct was something that most firms thought of as a compliance issue but now I would say it is very firmly on the agenda of executive management and boards and that’s certainly something we welcome.

We know that firms now understand the cost of getting this wrong in terms of regulatory fines, redress and litigation costs but also reputational damage. But firms also now recognise the benefit of good conduct performance in terms of building customer trust and the importance of building a positive reputation for fairness. In a speech I recently gave to the consumer credit industry, I said that good outcomes for consumers mean good outcomes for fair trading businesses. And this is true for all businesses, regardless of the sector they operate in.

And as a conduct regulator, we are now more focused on the big issues that matter, and are getting better at identifying the risks to consumers in this and other markets. While real progress is being made, it is important that firms continue to consider good consumer outcomes in all aspects of their business - from the boardroom to the adviser dealing with the end-customer. And I have no doubt that the new MMR requirements provide a good framework to achieve this.

Life after the MMR

So, after many years of having lived and breathed the MMR it finally happened on 26 April. And despite numerous headlines about intrusive income and expenditure checks, it has, in the main been very much business as usual for most firms. Lenders have carried on lending and consumers are still getting mortgages. The Council of Mortgage Lenders (CML) has predicted that gross mortgage lending in 2014 could reach £200bn, a big increase on the low of £135bn in 2010. The CML has also suggested however that moving forward we may see a gentle slowing of lending activity as a result of the continuing impact of tighter lending rules and a softening of the London market. We, like you, are interested in seeing what actually happens in this regard.

Impact on consumers

It is probably too early to be able to assess the overall impact of the MMR but we always knew that there were certain groups of consumers who would be more impacted by the new responsible lending rules than others, such as those seeking interest-only mortgages, the self-employed, those who previously needed to self-certify their incomes, and those with a poor credit record. 

However, when we look at our data, it shows a downward trend in lending to all of these consumer groups since 2008, highlighting the fact that lenders’ risk appetites substantially tightened well in advance of the MMR. 

For example, interest-only lending has dramatically reduced from 32% in 2007 to around 6% currently. Some lenders have chosen not to offer interest-only mortgages and some are worried that the regulator views interest-only mortgages as ‘toxic’. Let me be clear on this: we have always said that interest-only lending can be a perfectly sensible option for some consumers – but that using interest-only to stretch affordability and hoping that things will turn out OK eventually is not sensible and, as we have seen, stores up problems for the future.

Anybody here with an eye on our work with the credit industry will see how much emphasis we are putting on affordability being the key consideration for all lending decisions. I’m sure all of you here would agree with this sentiment. And we always knew that the greatest impact would be felt by consumers with impaired credit, many of whom could only get a mortgage by self-certifying their incomes. So today, new customers with similar characteristics will find it hard to obtain a mortgage and those with existing mortgages will find it hard to move to a new product.

But we also recognised that there would be a number of perfectly credit- worthy existing mortgage borrowers who would also not be able to pass the new affordability tests. And lenders told us that they wanted the flexibility to be able to help these borrowers and to minimise the impact of the new rules.

So it is disappointing to hear from various sources that some lenders are not applying the transitional provisions in the way that we had expected. Instead some firms are applying strict affordability tests when the rules do not require them to do so, resulting in existing customers who are not looking to increase their debt from being unable to switch to a new deal.

We have seen numerous examples of this. Customers who have been refused a switch to a product with a lower monthly payment, despite the fact that they are already managing to pay a higher monthly payment, on the grounds that the new loan is not affordable.

Others where borrowers are looking to downsize and so substantially reduce their monthly payments and have been told that the new payments are not affordable. This is not common sense and I would question whether firms are truly thinking about their customers’ best interests. I would urge you when faced with such situations to ask: is refusing this change a good outcome for that consumer? Will they be better or worse off if we allow them to downsize or move to a better deal without borrowing more?

And more recently, the Minister for Pensions has expressed concerns that the stance some lenders are taking is resulting in consumers stopping their pension contributions in order to make the mortgage affordable. Under our rules, pension contributions are not considered to be committed expenditure because the borrower has the ability to flex pension payments and could, for example, reduce the amount they pay into their pension for a period, prioritising instead their mortgage payments. So we expect lenders to exercise judgement as to the extent to which they need to factor pension contributions into an affordability assessment. 

We think that some of the poor customer outcomes we are seeing are a result of firms having built fixed advised sales processes that make policy exceptions difficult to cater for. And we know from some firms, that their advised sale process will not allow the affordability tests to be easily switched off for existing customers who could benefit from the transitional provisions.

But I would urge firms to look more closely at their interpretation of the rules to see whether this is really delivering the right outcomes for consumers, because in some of the cases we have seen this does not appear to be the case.  You may have seen that recently it was reported that Ben Bernanke, former Chairman of the Federal Reserve, had tried to remortgage and had been turned down because of affordability issues – perhaps a good example of this not being the outcome the lender intended.

Being able to help existing borrowers is particularly important in view of rising interest rates. We don’t know exactly when this will happen but most commentators expect the base rate to rise sometime next year. And although we are unlikely to see rates move up very quickly, many borrowers will find any increase difficult to manage. In the absence of wage inflation, low mortgage rates have provided a number of borrowers with breathing space and lender forbearance has been a big help to those in financial difficulties.

Earlier this year we published the results from our latest arrears thematic work and suggested that firms should be taking a pro-active approach by considering which borrowers would be most impacted by rate rises and developing strategies for engaging with them early. I would hope that this is something that lenders have already started to work on in order to minimise the risk of payment problems in future. 

Thematic work

We always said that we would undertake early discovery thematic work to look at how firms have embedded the new rules and to assess the impact and the outcome for consumers. The first phase of our work on advice is now underway and includes a wide range of intermediary firms and lenders.

We have three key objectives and so will be assessing:

  • whether the firm has executed a cohesive, joined-up mortgage advice strategy
  • whether the firm has a well-designed mortgage advice process – one that is engaging, supportive and flexible and where the staff are well-trained and capable, and act in the consumers’ best interests, and
  • whether the firm has a robust monitoring and oversight procedure in place in order to be able to identify poor outcomes such as providing unsuitable advice and also to ensure that the advice process drives positive outcomes for consumers

To do this, we will be undertaking consumer research, mystery shopping, file reviews and firm visits. While it is too early to say very much about this work, I can say that early indications show that there may be some unintended consequences for consumers in the way firms have interpreted the new advice rules. We plan to publish our findings in June 2015 with the aim of helping firms to move beyond prescriptive compliance with MMR rules and strive to deliver best practice and good customer outcomes.

Between now and then my question to you is – are you confident that your firm’s advice strategy is delivering the right outcomes for consumers and do you have the right quality assurance process in place to provide you with this comfort?

It is unfortunately too early to say very much about the next phase which will focus on responsible lending, but what I can say is that we will be adopting a very similar approach and will have the same aims and objectives.

Mortgage Credit Directive

As you know, regulation never stands still, and just when firms thought they could breathe a sigh of relief, along comes the Mortgage Credit Directive (MCD). Mindful of the impact of regulatory overload on firms, our policy colleagues were actively involved in the negotiations on the Directive. The end-result has been positive and, compared to some European regulators, we are very much ahead of the curve in establishing a regulatory regime with consumer protection at its heart. And it also means that we are now able to implement the MCD in a way that relies on our existing mortgage regime as much as possible, minimising disruption and costs to firms.

So, we do not need to change our existing rules on responsible lending, advice, and arrears management, areas that were strengthened through the MMR and already meet the Directive requirements.

But disclosure is one area where we have no discretion to deviate from the Directive and so the European Standardised Information Sheet, or the ESIS will replace our own Key Facts Illustration from 22 March 2019.

We know that in some instances, firms will incur significant costs in migrating from the KFI to the ESIS so we will be using a transitional provision in the Directive to allow firms to continue to use the KFI until the deadline date, providing they make certain ‘top up’ disclosures to enhance comparability between the KFI and what will be required in an ESIS. 

Second charges

We will also be bringing second charge lending into the mortgage regime with the implementation of the MCD. We know that the second charge market is important for consumers who wish to borrow additional money and have equity in their home. And we recognise that there are differences from the first charge market, particularly around customer profile and the purposes for taking out a loan. So it is important that any new regulatory requirements enable this market to function effectively, while offering consumers adequate protection from the risks associated with taking out a secured loan.

Those risks are present whether the loan is secured by a first or subsequent charge. Ultimately, the customer’s home is at risk. Evidence we have gathered from firms points to those risks being greater in the second charge market.

For instance, we know that a far higher proportion of customers in the second charge market take out a loan for debt consolidation purposes. 

Consolidating debts through secured loans can be the right solution for some consumers where it is affordable. But consumers struggling to cope with debt may feel pressured to find a solution and enter into an agreement that prolongs a period of financial stress. And the high arrears rates in the second charge market are a concern and are aligned with  the ‘poor tail’ of first charge lending that we sought to address through the MMR. 

To address these risks, we believe that the key protections of our mortgage regime should be applied to the second charge market. So, where a customer wants to take out a second charge mortgage, the product meets their needs and circumstances and is demonstrably affordable. And where a customer does fall into payment difficulties, they are treated fairly. 

As is the case in the first charge market, we propose that second charge lenders’ affordability assessments should take into account a customer’s verified income, credit commitments and basic quality of living costs.  Both now and in the event of known changes in circumstances or an expected increase in interest rates. 

Of course, affordability is only one aspect of getting a second charge mortgage. It is also important that a consumer gets a loan that meets their needs, where they understand the risks - and where they are not persuaded to borrow more than they need. Where a sale involves interaction, consumers receive advice from sellers that are appropriately qualified, which is why we propose applying our Mortgage Conduct of Business sales standards to the second charge market and applying the need for the Level 3 qualification. 

And at the back end of the process, we are proposing to apply our mortgage rules on the handling of payment shortfalls and repossessions to second charge mortgages. We believe these rules - strengthened over recent years following thematic reviews into the first charge market - will provide vital protection for consumers facing difficulties, whose homes might be at risk because of second charges.

I realise there has been much speculation about the regulation of buy to let. The Government is currently consulting on this area. The consultation includes provisions for what it terms ‘consumer buy to let’.  As it is proposed that the FCA is given powers to supervise compliance with the Government’s regulations, we will be addressing the practicalities of this in a forthcoming consultation.

Ageing population

Another topical theme is the ageing population. There have been reports that older borrowers are finding it more difficult to get a mortgage, and that this is partly down to our rules. Our rules do not aim to discourage lending to older consumers. Affordability is the key, whatever the age of the borrower. In fact, the income of older borrowers, such as pension income, can be very stable. Where consumers have not yet retired, we expect lenders to consider whether they are likely to be able to afford the mortgage if it extends into their retirement, based on what the lender knows when they are assessing the application. But we recognise this is not an exact science. It is not possible to predict what a borrower will do tomorrow. A proportionate and common sense approach is all we expect. Beyond that, it is for the lender to set their own criteria.  

There is also a question around what will happen to older borrowers with interest-only mortgages who are unable to repay their loan at the end of the term. For some, it may be appropriate to take a lifetime mortgage. But not for all – which is why we require advice to be given to all consumers who are taking a lifetime mortgage. We are seeing some product innovation in this space – and we will be keeping a close eye on this, working with the industry to see whether this considers the right consumer outcomes.

FPC interest

I wanted to comment on the recent Financial Policy Committee (FPC) interventions to increase the mortgage interest rate stress test and apply a loan to income cap because there have been claims that the FPC moves were made because the MMR had failed. This is absolutely not the case. The FPC interventions do not undermine the MMR – they support it. Conduct regulation is concerned with affordability at the customer level whereas the FPC is concerned about consumer over-indebtedness at a macro-prudential level and the impact on the wider UK economy.

And the Chancellor is keen to ensure that the FPC has ‘everything it needs to guard against risks in the housing market’ and, as a result, has committed to giving the FPC new powers over mortgages. The FPC has asked for powers of direction over loan-to-value and debt-to-income tools for both residential and BTL lending.

HM Treasury is currently consulting on the tools for residential lending and has committed to consult separately on the BTL tools in the New Year, so I think this means that you can expect to see the FPC taking a lively interest in the housing market in future.

Conclusion

Many changes have been made to deliver a sustainable market and to deliver better consumer outcomes but as always, there is still more to be done, particularly in the application of the transitional provisions for existing customers. I would strongly encourage lenders to review their policy stance to ensure that they are making common sense judgements that deliver sensible consumer outcomes. Telling customers that they cannot demonstrate affordability and then reverting them to a product that is more expensive than the product that was deemed unaffordable is not a good conduct outcome and we will be looking much more closely at outcomes like this in future.

I would however like to end today on a positive note and that is in respect of the pro-active interest-only maturity work that the industry has embarked on over the last year or so. Findings from the 2020 maturity communication exercise were encouraging and we are pleased to see that firms have embedded our guidance and most are offering borrowers a range of options to help reduce the risk of non-payment at maturity.

We recognise that this is a long tail risk and that real progress is being made but we also understand that this is a shared problem and we would encourage borrowers with no interest-only repayment strategy in place to work with their lenders now to minimise problems in the future.