My take on the rest of the MMR proposals

Posted on 21 October 2009 by Ray Boulger

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Following on from my blog post on Monday on the MMR I note that less than 24 hours after post the FSA have amended the figure I queried for the increase in property prices over the 10 years to the onset of the credit crunch from 300% to 200%.

As foreshadowed in that blog I will now comment on aspects of the MMR other than self cert and fast track.

In the foreword to the MMR the FSA says “We recognise that the market has worked well for many consumers: the vast majority of mortgage borrowers will come through this recession meeting their mortgage payments.”

This should be born in mind when assessing the changes the FSA is proposing. Although regulation obviously needs to address issues at the lowest common denominator level, that should not be at the expense of an unnecessarily negative impact on the “vast majority” of mortgage borrowers by piling extra costs on firms, which inevitably will be passed on to consumers. It also should not prevent a consenting borrower from entering into a contract with a consenting lender, subject to appropriate safeguards.

Defining what those safeguards should be is a challenge but a good starting point is the requirement in The Financial Services and Markets Act (FISMA) that the FSA should have reference to the “general principle that consumers should take responsibility for their decisions.” They can only be expected to do this if the benefits and risks of any particular mortgage are explained clearly to them and it is encouraging that the FSA now recognises that consumers do not use the KFI as they intended, i.e. for shopping around, but mainly rely on the oral advice or information they receive.

Most lenders already base the maximum amount they will lend on an affordability calculation, sometimes using actual expenditure as disclosed by the borrower and information from the credit reference agency and sometimes using averages from the National Audit Office. The FSA wants to go much further and make the mortgage application process far more intrusive by requiring borrowers to disclose not only committed expenditure (which lenders generally already require) but also discretionary expenditure on “food and drinks, alcohol and tobacco, clothing and footwear, household goods and services, health and personal care, transport, recreation, culture, restaurants and hotels, holidays and other miscellaneous goods and services.”

Going through a detailed budget planner with some clients, particularly first time buyers, can be a helpful exercise for the client as well as the adviser, but for others a regulatory requirement to do so is insulting. Advisers and lenders should be given discretion as to how much of this detail is necessary, depending on the client’s status. In any case most people don’t say that my discretionary expenditure is £x and so I have £y left for my mortgage. They look at how much their mortgage and other committed expenditure is each month and then work out how much is left to spend on non essentials or save.

Furthermore, rather than trying to micro manage people’s budgets, the interest rate assumed for the affordability calculation is much more important. The FSA is prescribing 2% as the increase in rates to use for affordability purposes but the danger of this is that by specifying a rate some consumers will rely on it for their own budgeting purposes. For anyone taking out a tracker today a 2% increase is too low a rate to use, whereas for someone taking a 10 year fix it would be fair to use the actual rate they are paying.

The FSA is also proposing that all affordability calculations should be based on a 25 year repayment mortgage. Why? With the retirement age increasing it will be perfectly feasible for people to take out a mortgage for a longer term than was sensible a few years ago. If a 25 year old with a retirement age of 68 wants a 40 year mortgage to keep initial costs down what is the problem?

The FSA has recognised that many borrowers whose mortgage is processed on a non-advised basis think they have had advice and also that some sales recorded by firms as non-advised are really advised. It accepts that some consumers do not want advice and it would be wrong to force them to have advice. It therefore proposes retaining both advised and non-advised sales but enhancing “the protections consumers have in a non-advised sale by imposing a basic standardised affordability and appropriateness test.”

This seems sensible but I worry that if the information on discretionary expenditure demanded from clients for an advised sale is as intrusive as the FSA proposes more clients will choose the non-advised route. I suspect this is the exact opposite of what the FSA would like.

Once a borrower has been asked more questions about affordability he/she will be even more likely than now to think they are getting advice to take a particular mortgage. Most lenders aren't keen to offer advice to their direct customers because of the more onerous regulatory and staff training requirements and so any extra questions they have to ask the customer will present a challenge to lenders (and those brokers who do primarily non-advised sales) to make sure their customer knows they are not giving advice.

The proposal to require all mortgage advisers to become approved persons with individual broker registration is very sensible and should enable the FSA to deal much more quickly with the minority of rogue elements in our profession. The only surprising thing is that the FSA choose not to do this from day 1, in line with the policy of its non statutory predecessor, the Mortgage Code Compliance Board.

Gordon Brown’s proposal early this year to cap LTVs at 90% was naïve and this review very sensibly recognises that LTV caps would be inappropriate. Affordability is the key issue and proper risk based pricing is required for higher risk mortgages, not a ban. Logically if mortgages above 90% LTV were banned all unsecured lending would have to be banned as well because that type of lending is obviously even riskier!

Likewise, once it is accepted that affordability based lending is appropriate a loan to income cap would have been superfluous.

Some of the changes the FSA is proposing are no doubt partly based on its re-assessment of
the role of the consumer. Previously it assumed consumers would act rationally to protect their own interests but now it believes consumers have "behavioural biases.” Because the loan is a means to an end, for example a home or a car, they fail to focus on the details of the loan and hence the regulator needs to become "more interventionist to help protect consumers from themselves".

It also suggests that consumers need "re-educating away from the idea that renting is bad and home ownership good, and away from seeing property as an investment." I suspect it will struggle with that one!

The FSA suggests its scope should be extended to regulate second charge mortgages and buy-to-let (BTL) mortgages. The former is long overdue and it is almost unbelievable that the reason The Treasury originally decided that the FSA should not regulate second charge loans was that “your home is not normally at risk with a second charge loan.”

Bringing BTL mortgages under the FSA umbrella will pose many challenges and when The Treasury consults on this shortly I expect the responses to be much more mixed than those which will be received on second charge lending. BTL is an investment and so should the regulation be as an investment or as a mortgage, or both?

There is a huge difference between the amateur landlord with one or a few properties and the professional with perhaps over 100. If one is going to regulate mortgages for the landlord with, say, 100 residential properties and also a couple of shops or office blocks, why regulate one but not the other? I think it may be necessary to find a way of regulating BTL mortgages for the amateur landlord but not the professional, which then presents the problem of where to draw the dividing line.

The FSA says that “We are not seeking to pre-empt the outcomes of the debate: the aim is to stimulate a wide-ranging discussion.” Unlike the Government, whose so called consultation papers have often been a sham (just think of HIPs) the FSA has demonstrated a willingness to listen to responses to its consultation documents. For example the final version of MCOB had some significant changes from the original and more recently the huge response from brokers, encouraged by AMI, to the massive increase in FSA fees originally proposed for brokers for this year resulted in much revised figures with only small increases.

Therefore I would encourage every reader to engage with the FSA and answer the questions summarised in Annex 1 by the deadline of 30 January. Why not also encourage clients who think they will be adversely affected by any of these proposals to also respond to those questions which concern them. The more responses to this discussion paper the FSA gets the more influence they will collectively have on its final rules.

Categories: Buy to let, HIPs, Interest rates, Mortgages, Personal finance, Regulation

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