Mortgage lending – the new landscape

The Mortgage Market Review (MMR) was a comprehensive review of the mortgage market undertaken by the former Financial Services Authority (FSA), which started with a discussion paper in December 2009 and culminated in a policy statement and final rules being published in October 2012. The MMR set out the case for reforming the mortgage market to ensure that it is sustainable and works better for consumers.

The MMR changes will come into effect on 26 April 2014. The key areas impacted by the MMR changes are:

• responsible lending requirements;
• changes to requirements for the sale of interest-only mortgages;
• transitional arrangements for existing loans;
• advised sales and execution-only sales;
• high net worth individuals.

Responsible lending

The MMR makes it clear that it is the responsibility of the lender to assess the affordability of the mortgage. Where the mortgage is introduced by an intermediary, the intermediary is required to ensure that the customer meets the lender’s known eligibility criteria, but there is no requirement on the intermediary to assess affordability.

In assessing affordability, the lender is required to verify income in every case, and must take into account the committed expenditure of the customer, together with their basic essential expenditure and living costs. The lender is also required to stress affordability for the impact of future rises in interest rates. As part of the affordability assessment, the MMR rules also require lenders to take into account future changes to income and expenditure about which they are, or should reasonably be aware.

The MMR rules do not rule out lending into retirement, and lenders can base their assessment of affordability on the customer’s expected retirement age, rather than state pension age. Lenders will be expected to assess income into retirement in deciding whether the loan is affordable. Existing borrowers will also be subject to an assessment of affordability should they wish to extend their loan beyond their expected retirement age.

Borrowers varying existing mortgage contracts will be subject to an affordability assessment if they increase their loan, or where they make a change which has a material impact on affordability – this could include (but is not limited to) extending a mortgage term into retirement, or changing the repayment type.

The MMR rules require each lender to have a comprehensive responsible lending policy, which will set out the factors it will take into account when assessing affordability and how it will comply with the new MMR requirements.

Interest-only mortgages

Lenders can continue to offer interest-only mortgages but, in doing so, they must ensure that there is a credible strategy in place for repaying the capital, and obtain evidence of that strategy before advancing the mortgage.

Speculative strategies for repayment, such as house price increases, cannot be accepted and lenders will have to operate within a clearly defined interest-only policy.

Detailed records regarding the decision to lend on an interest-only basis will require to be maintained. The lender is also under an obligation to contact an interest-only customer at least once during the life of the mortgage to ensure that the repayment strategy remains in place and still has the potential to repay the capital at term.

A lender’s responsible lending policy must set out how it will manage interest-only sales, ensuring compliance with the new interest-only requirements.

Transitional arrangements

The finalised rules offer lenders the flexibility to make exceptions to the new affordability and interest-only rules for existing customers where, in essence, there is no increase in the amount being borrowed and where the lender believes that the proposed transaction is in the best interests of the customer.

Advised sales and execution-only sales

All interactive sales where there is a spoken or interactive dialogue with the consumer during the sale will be advised, and advice must be given by a suitably qualified adviser. Under the MMR rules, determining appropriateness lies at the heart of giving advice. Firms advising customers – and the advice rules described in this section apply to both lenders and mortgage intermediaries – must determine whether the contract, or contract variation, is suitable for that customer. The rules are also clear that firms should not encourage customers to opt out of advice. Forbearance cases remain exempt from the advice rules.

Vulnerable customers are always required to receive advice under MMR. This includes customers seeking equity release products or right-to-buy products, sale and rent back customers, and those whose main purpose is the consolidation of debt.

The only exceptions where lenders and intermediaries will not have to advise, and will be able to sell, and vary, mortgage contracts on an execution-only basis are where:

• it is a wholly non-interactive sales process, such as over the internet or by post;
• the customer is a high net worth individual, a mortgage professional or the loan is solely for business purposes; or
• the customer has rejected the advice given and wishes to proceed with a product of their own choice.

For an execution-only sale to take place, a firm must always disclose to the customer that they are not receiving advice and that they will be forgoing the protection of the advice rules. In most cases, the customer will also have to positively elect to proceed on an execution-only basis.

Firms are required to have an execution-only policy which will set out the amount of execution-only business they intend to undertake, and the processes/procedures that they will put into place to ensure that they are compliant with the execution-only rules.

The FCA intends to monitor and supervise closely the levels of execution-only business undertaken by firms, and to investigate any unexpected “spikes” in execution-only sales.

High net worth individuals

Some key exceptions have been made by the FCA in respect of responsible lending and the interactive sales process for high net worth customers (defined as someone with a minimum net annual income of £300,000, or minimum net assets of £3 million). These are:

• interactive sales can be conducted on an execution-only basis (provided the customer has been made aware of the consequences of not proceeding on an advised basis and has positively elected to proceed);
• it is not compulsory for high net worth customers who are also vulnerable customers (as defined by FCA) to receive advice; and
• lenders can decide how best to determine a customer’s affordability, but are still subject to the overarching responsible lending rules.

Impact on the market

With six months to go until the introduction of the new rules, it is still too early to predict exactly how they will affect the market. There are some likely changes, however, that we can anticipate.

One is a move to a market in which most borrowers take out a mortgage only on the basis of advice provided as part of the sales process, whether through a regulated mortgage intermediary or by the lender itself. Consumers will need to understand that there will be new rules and procedures for providing them with advice, and that this will affect the way in which mortgages are sold. And these changes will affect not just the sale of new mortgages, but variations to existing contracts as well.

The new rules do allow lenders to offer an execution-only option in limited circumstances and to advance mortgages to customers without giving advice. At the same time, the FCA has made it clear that lenders will not be compelled to lend on an execution-only basis.

One likely outcome is that some lenders may opt to offer only advised sales, and the proportion of mortgages advanced without advice may be much lower in the future. The anticipated reduction in the number of mortgages sold without advice may lead to changes in the way mortgages are distributed, and in the balance between loans that lenders advance directly to customers and those that are distributed through brokers. But the extent to which this balance may change may not be clear until after next April.

Lenders do not have to wait until next April to make some of the changes, and many of them are already anticipating rules that will require a more prescriptive approach to assessing the affordability of the mortgage for the customer.