Second charge mortgages – improving outcomes for consumers

In some cases, the quality of advice could be improved, particularly when consumers are consolidating debt.  

It is important that advisers focus both on whether consumers are eligible for the loan and if it is genuinely suitable for their needs and circumstances.

We saw examples of advisers not discussing the root causes of growing unsecured debt with consumers during the advice process. This meant it was not clear whether consolidating debt into a second charge mortgage would be an appropriate solution.  

We saw several cases where advisers appeared to encourage consumers to consolidate additional debts to enable the case to pass the lender’s affordability test, without recording clear reasons to explain why this was appropriate. This included some cases where the consumer had wanted a loan to fund home improvements, but was advised to consolidate a relatively large amount of debt to pass the affordability test. This could be much greater than the amount the consumer originally requested for home improvements. 

Some files were missing key details needed to assess if debt consolidation was appropriate. These included interest rates of existing debts, accurate balances and associated costs like early repayment charges. Without this information it would be difficult for an adviser to assess the appropriateness of consolidation.

Documented recommendations sometimes lacked clear reasoning. This meant it was not clear if consumers would fully understand how the loan met their needs or the longer-term implications. 

Some advisers did not appear to consider and provide information about other options. Some firms told consumers upfront that they could not help them consider other options, thus shutting down any further discussion. It is important that consumers are clearly informed about other options and given a proper opportunity to consider them. 

We expect firms to act in a way that avoids causing foreseeable harm. Advisers must also take reasonable steps to help ensure that recommendations are suitable for consumer needs and circumstances. If a second charge mortgage is not suitable, it must not be recommended.

Where the main purpose of a mortgage is debt consolidation, MCOB 4.7A.15R requires firms to (where relevant) take account of:

• The costs of increasing the period over which a debt is to be repaid. 
• If it is appropriate for the customer to secure a previously unsecured loan.
• Where it’s known the customer has payment difficulties, whether it would be appropriate for the customer to negotiate an arrangement with their creditors rather than take out a regulated mortgage contract. 

Consumer communications should be designed to take account of the customer’s level of financial understanding, and discussions should be interactive and not limited to scripted statements.

Firms should provide clear and fair information about the implications of consolidating debt, including the potential consequences if the consumer cannot keep up payments. The Consumer Duty[3] requires firms to ensure consumers can make informed choices in their interests. This includes making sure consumers have the information and support they need, when they need it, to make and act on informed decisions. Firms should also allow consumers time to consider this information. In addition, reflection period requirements apply to lenders through MCOB 6A.3.4R.

Case study

Good practice

• Advisers personalise advice, and where appropriate challenge customer assumptions.
• They highlight alternative options to consumers in an open way and give them the information and time needed to consider them. 
• Files clearly explain and document the reasons for their advice and recommendation.

Poor practice

• Advisers focus on securing sales at the expense of the quality of the advice and good customer outcomes.
• Advisers fail to consider whether consumers with known payment difficulties should negotiate an arrangement with their creditors rather than take out a second charge mortgage to consolidate debt.
• Advisers close down discussions about alternatives, or gloss over them in call scripts. 
• Advisers don’t collect information about interest rates or other details of existing debts such as early repayment charges and so cannot factor this information into their recommendation.  
• Advisers encourage consumers to consolidate additional debts solely to pass the lender’s affordability test. 
• Advisers focus on the monthly payment reductions from debt consolidation without also helping the consumer to fully understand the trade-offs such as the increased total cost. This can make it difficult for consumers to make an informed choice.   

Weaknesses across the distribution chain can affect the quality of affordability assessments and result in consumer harm, such as mortgage arrears and hardship from their other financial commitments and expenditure. This can damage a consumer’s credit file, restrict their future financial options and cause often already vulnerable consumers difficulties in meeting their financial commitments.     

We saw examples of good practice in our review. For example, some firms had gathered and assessed detailed income and expenditure information using different sources. This included customer bank statements, which were cross-referenced with other sources of information.

However, we also saw ways in which firms could improve expenditure assessments.

The statistical data used in some expenditure assessments did not appear to realistically reflect the consumer’s expenditure, based on their credit profile. Many consumers applying for second charge mortgages had high levels of existing debt, and their expenditure patterns appeared unlikely to reflect ‘average’ levels. But firms did not always appear to consider this. 

Where intermediaries and lenders assessed actual customer expenditure (either as self-declared or via evidence such as bank statements), their probing could sometimes have been deeper. For example, we saw some customer assessments exclude expenditure items on the basis that they were ‘one-off’ without appearing to consider whether this was realistic. We also saw examples of intermediaries asking leading questions when taking expenditure information from customers, risking them providing artificially low figures.  

We expect firms to have open conversations with their customers. Where customer-provided expenditure information is used, lenders should ensure they apply a common-sense approach and not accept information provided at face value if they have reason to doubt it. Where evidence such as bank statements is used, it should cover an appropriate period to provide a realistic picture of the customer’s expenditure to avoid causing foreseeable harm.  

We saw some lenders appearing not to consider some basic quality-of-living costs in their expenditure assessments, including household goods and repairs, and childcare costs, even where these items seemed relevant. Others had an inconsistent approach to these costs.

For example, some lenders assumed that no childcare costs applied when a child reached primary school age. Others relied on the intermediary to provide figures for childcare costs and didn’t question cases where no costs were stated.  

Some lenders had no clear process for considering the cost of household goods or repairs. This could affect affordability, particularly where a consumer has little spare income after mortgage payments and other expenditure.  

We also saw an intermediary not passing on full expenditure details collected from the consumer to the lender, even though this could have materially affected the lender’s affordability assessment. 

Good practice

• Lenders proactively review their statistical expenditure data as and when economic indicators suggest there have been material changes, rather than waiting for a set annual review point. 
• Lenders include household goods and repairs as a specific expenditure item in their affordability assessment, setting appropriate minimum figures where the customer-declared amount is unrealistically low. 
• Lenders have systems and controls in place to challenge information provided by intermediaries where the intermediary has made repeated changes to their initial expenditure assessment. This means the lender can help ensure there is a clear rationale explaining any supposed increase in the customer’s ability to afford higher monthly repayments than initially recorded.  

Poor practice 

• Firms guide consumer conversations about expenditure in a way that may encourage consumers to understate their expenditure. 
• Intermediaries do not pass full expenditure information on to lenders, for example, by omitting some items the consumer has declared.
• Lenders don’t have clear policies around items such as childcare costs, so different underwriters interpret these items differently. 
• Lenders apply a blanket policy which assumes no childcare costs apply once children reach primary school age, even where both parents are in full-time employment. 
• Lenders do not account for household goods or repairs when assessing affordability, stating they expect consumers to either pay such costs out of remaining disposable income or by taking out further credit.
• Lenders ignore hard-to-reduce costs such as pets and smoking in their expenditure assessments (even where there is evidence these could be material costs for the customer) on the basis that customers can cut these out. 
• Lenders accept customer-declared expenditure at face value, even when there are clear indicators this is inaccurate. For example, accepting an unrealistically low figure for food shopping, despite the customer stating that a significant amount of recent debt on their credit card was run up through food shopping. 

Most lenders distribute second charge mortgages through intermediaries. This means intermediaries are crucial to ensuring products meet customers’ needs and objectives, as well as gathering details of income and expenditure information for the lender’s affordability assessment. Lenders also use intermediaries to identify information about customer vulnerability.

We found the quality of advice provided by intermediaries, and the way they gathered customer expenditure information, could be improved. In some instances, they did not appear to pass on information accurately to lenders. We saw some intermediaries appearing to overlook potential indicators of customer vulnerability that could have been relevant to the application. 

Lenders’ oversight of intermediaries varied. Some were relatively well-documented, but others were more ad hoc. Outcomes testing could also have a narrow focus. Intermediaries primarily measured outcomes according to application acceptance rates by lenders. Lenders focused on customer satisfaction at the point the customer received the funds, and arrears levels. 

Lenders are responsible for affordability assessments, as set out in MCOB 11.6. SYSC 8 makes it clear that firms cannot outsource or delegate their responsibility for complying with regulatory obligations.

The Consumer Duty[3] requires all firms to act to deliver good outcomes to customers and to avoid causing foreseeable harm. Given the inherent risks in this distribution model, we expect firms to have robust arrangements to monitor outcomes. They should test whether their products and services are meeting the needs, characteristics and objectives of the target market across the product’s life. They should also test whether the products are being sold to the intended target market. Lenders and intermediaries should also carefully consider how weaknesses in relationships between firms in the distribution chain may cause consumer harm. They should have processes to identify the root causes of any failures to deliver good outcomes so they can resolve them.

Both lenders and intermediaries should consider whether they are collecting the right management information to assess customer outcomes. They should both also consider if they have the right information flows to monitor their relevant products and services.  

Good practice

• Lenders monitor intermediary performance using a range of qualitative and quantitative indicators to guide their risk-based oversight and identify any gaps that would affect customer outcomes. 
• Intermediaries monitor outcomes through sources such as independent customer surveys undertaken at different stages of the customer journey, including for consumers that did not complete the process.

Poor practice

• Lenders monitor individual intermediary performance by how complete their applications and documents are, without considering broader outcomes. 
• Intermediaries monitor customer outcomes through lenders’ acceptance rates, rather than assessing the quality of their own advice.
• Lenders focus on customer satisfaction at the point that funds are released to customers and don’t consider customer outcomes across the product’s life.  

We saw some second charge intermediary firms reassessing their fee charging models before the Consumer Duty was implemented in July 2023. Some moved away from the 2 more traditional options (a percentage of the loan amount or a fixed fee) to other more bespoke fee models. For example, a menu of tasks linked to an hourly rate. However, intermediary fees remain high compared to, for example, the first charge market. While some firms set a maximum fee cap, the intermediary fees we saw typically represented 2.5% to 15% of the loan amount, with the majority charging between 10% and 12.5%. These fees are in addition to the lender’s fees.

Most intermediaries could not provide sufficient detail about their costs and income to fully explain how they reached their fee levels. We found most firms’ business models were based on high customer acquisition costs with low customer conversion rates. This means the few customers that complete and pay a fee cover the costs for those who don’t. PRIN 2A.4.2R requires firms to ensure that their products provide fair value. As part of their Fair Value Assessment (FVA) firms should ensure a reasonable relationship between the product’s benefits and limitations and the total price customers pay. Firms should not rely on inefficient business models to justify high costs to consumers. They should challenge themselves to ensure their business models are effective and contribute to good customer outcomes.

We saw firms focusing on benchmarking as a key element of their FVAs, where firms compare their fees and services with other similar firms. However, in a market where firms tend to have similar levels of fees, they should not assume this means the fees offer value, particularly in a small, concentrated market like second charge mortgages.

We found that firms don’t routinely publish their fee information on their website. This makes it difficult for consumers to be able to compare fees between different intermediaries. All firms supplied an Initial Disclosure Document (IDD) outlining their fee charging model when they first engaged with the consumer. However, the first clear mention of the customer’s actual fee tended to come at the recommendation stage, after consumers had already invested time providing personal and financial information. This could make it less likely that the customer will shop around.

Good practice

• A firm streamlines their processes which, in turn, reduces their overall costs and results in a reduced fee for consumers. The firm continuously finds ways to embrace technology, and reduce costs, while still ensuring good outcomes for the consumer.
• Firms consider a range of factors, including the target market, benefits to the consumer, any product limitations, characteristics of vulnerability and total cost to the consumer when developing their FVAs.

Poor practice

• Firms that use an hourly rate to justify customer fees cannot provide sufficient supporting analysis of staff costs, time-based task metrics or rationale to justify the time taken for the tasks.
• Firms explain that the higher level of fees they charge consumers are because second charge mortgages cases are complex and time consuming. But in practice many recommendations are made within a few hours on the same day as the initial application, and firms are unable to justify the complexity.