The second charge, or secured loan, market caters for those seeking to borrow for non-house purchase related expenditures such as home improvements, debt consolidation, holidays and other consumer durables.
The proposed mortgage regulation excludes second charge – potentially making this an area of great confusion. After all, your client's property is still at risk if they do not keep up with repayments on a secured loan.
Why then, if second charge poses such a risk, did the FSA decide to exclude it from regulations?
The answer, perhaps, lies within the market itself.
The popularity of credit and debit cards continues to soar. As a proportion of total consumer spending, the use of credit and debit card spending has risen from 15% in 1992 to 44% last year. We have become the most indebted nation in Europe. We have record-breaking debts of £800bn and fears are growing that too many people are taking on unsustainable debts.
And Miranda Haines of the Citizens' Advice Bureaux says the problem is getting worse. “We have seen a million new cases of people with debt problems in the last year,” she says.
The potential demand for home-improvement products is huge and represents the third most common reason for taking out a loan, after debt consolidation and car purchases. In 2001, an estimated £13.6bn was lent for home improvements. By 2006 Datamonitor forecasts that figure will be £17.6bn.
But is second charge really the right way to go?
Of course, on a strategic level the consumer must be given the widest possible choice, and first charge borrowing, second charge borrowing and card-based credit all have their place in the market.
Indeed this approach is accepted by Ray Boulger of Charcol.
“For most people a second charge loan is poor value,” he concedes. “But for consumers with some adverse credit it may be a satisfactory route. A higher rate of interest on a modest loan might be OK. Therefore, there will be some occasions where a second charge mortgage will be best advice.”
Certainly, second charges are associated with speed, lack of formal valuation and the absence of legal input.
The secured loan market is principally regulated under the Consumer Credit Act (CCA) and, although this is currently being reviewed, many argue that this method of regulation is unsatisfactory due to its basic lack of 'teeth'. There is a growing consensus that second charge lending should now come within the scope of the FSA.
The CCA itself has been described as 'an Act of extraordinary length and complexity', covering a market for credit lending that has changed immensely in recent years. The growth of credit availability across the board is leading to practical issues that were not considered when the Act was first introduced. Clearly, after 30 years, the CCA does need to be updated.
The potential gap in regulation is well understood by the Treasury and others. Co-ordination is being addressed. John Fox is the lead officer on the CCA and mortgages officer at the Trading Standards Institute. “Legislation could not proceed before the end of 2003. We are likely to require a transition period and, with the new mortgage regime scheduled for 2004, it seems that both could be harmonised for mid-2004,” he says.
What is very clear is the determination that nothing will slip through the regulatory net.
The current financial limits of the CCA are recognised as inadequate. One example of this is the lack of a limit on the amount of a first charge loan to be regulated by the FSA regime, when logic would suggest that there be no limit for second charge loans for statutory protection.
The Finance and Leasing Association (FLA) is one organisation that believes a financial ceiling of £500,000 would be appropriate for consumer protection purposes and would meet the government's objective by bringing most credit agreements within the regulatory regime. However, in practice, it is highly unlikely that a second charge of over £500,000 would ever be written.
Other improvements centre on two key areas. “Firstly, the licensing regime needs to be beefed up, with local authorities actively visiting and monitoring the applicant,” says Fox.
“Secondly, basic penalties on the CCA are an all-or-nothing affair. We now need a system of other penalties, including fines, and awards of compensation to consumers.”
For many years the secured loan market has had the equivalent of the MCCB to monitor the compliance of brokers in the market, namely the Finance Industry Standards Association (FISA), founded in 1988. FISA had widened its involvement in enforcement and promoting best standards and, to this end, the body carries out monitoring visits, mystery-shopping, regular office inspections and other compliance-based activities.
Practitioners in the secured loan market express confidence in the current system. Robert Owen, managing director of The London Mortgage Company, says: “We only deal with FISA-registered brokers. We know they are subjected to regular audits and are very closely monitored.”
The proposed regime for second charges is causing intense debate. But during the consultation period the industry hardly took to the rooftops. As Tony Jones, managing director of Pink Home Loans, laments: “I am surprised that Pink were one of only two companies to highlight the issue during the consultation phase.”
Practitioners think it is an issue of scale. The first charge market is so different in size and complexity – with so much to get through on first charges alone over the next few years – that the second charge market really doesn't concern most lenders.
So is it a case of Treasury nonsense or Treasury nouse?
When questioned over the omission of second charge loans from FSA regulation, Simon Moyes, a Treasury spokesman, told Mortgage Strategy: “The purpose of mortgage regulation is to protect consumers when their house is at risk. The perception is that the home is not normally at risk when there is a second charge and the CCA applies.”
Self-evidently, much of the market is sub-prime. And, additionally, the appropriate documentation contains the disclaimer “Your house is at risk ” etc.
But the Treasury says that there is an answer to this.
“We are not aware of any instance where a house has been lost because of default on a second charge,” says Moyes.
However, the major bugbear seems to concern the opportunity missed. As Richard Hurst, communications manger at Future Mortgages, says: “Although we have no complaints to levy against the CCA, it seems to us that an opportunity has certainly been missed to bring all mortgage-related products under one body. As a lender, this situation is not ideal.”
But there are those who have some sympathy, including Gerry Bell, marketing manager (secured lending) at First National. He says: “We would have preferred a single regulator, but it could be that they have decided to take it in bite-sized chunks. This is the nature of life. Do a little, but make sure you get it right.”
From some, the Treasury gets short shrift.
“The Treasury has lost the plot,” says Charcol's Ray Boulger. “It does not understand what second charge lending is. The bottom line is that the second charge lender has exactly the same rights as the first charge lender.”
The Finance and Leasing Association would originally have preferred a purpose test as being the most sensible approach. But, as Hilary Platt, head of legal affairs, says: “Clearly the Treasury did not wish to regulate secured credit. What it wanted to do was to regulate the house purchase market. The point is that the way to regulate the two markets could be conceptually different. After all, one is a mortgage market and one is a credit market. The mortgage is a distinctive product and the secured personal credit market is typically a second mortgage and these compete with unsecured personal loans.”
FISA also wanted a purpose test for mortgages. Its view remains that it believes the FSA regime is wholly appropriate for house purchase and mortgage lending, but that the CCA regime is more appropriate for credit intended for general use.
But the Financial Services Consumer Panel has some strong views on the subject. The chairman of the panel told Mortgage Strategy: “The Treasury proposals to regulate mortgages will be insufficient to protect consumers. This will leave in place a system of dual regulation which will simply continue to confuse people.”
Other institutions tend to take a more pragmatic view. Sue Anderson, head of external affairs at the CML, says: “In an ideal world we would like it all in one place. But we can live with the situation. And we must say the second charge market is a very mixed bag. The greatest risk is on the first charge. To concentrate here seems right. The administrative problem may have constituted a large component of the considerations.
“It is true that default on the second loan can threaten both the property and the integrity of the first charge. But quite clearly there is not a huge market problem at the moment.”
It might appear strange for a hitherto unregulated market to start pointing fingers at a regulated one, notwithstanding some obvious shortcomings.
This is the view of Robert Owen.
“The starting point for somebody whose market is not regulated is not to start saying 'Well, if we're going to be regulated, we want those guys over there who are currently regulated to be regulated in a different way'. They should get on with their new regulation. Two or three years down the road, if the regimes aren't quite right, it can all be looked at.
This view, with a strong caveat, finds some support from Paul Newey, managing director of Ocean Finance. “At the moment the second charge market is working smoothly. We welcome regulation, but are not concerned how,” he says. “Our concern is that some people on the periphery may try to get into second charges. All the good work by the FSA will drive out the cowboys and they will set up across the road in seconds. This is certainly an issue for us.
“There is a mass of regulation to be got through. It may be administrative overload that is forcing regulation this way.”
The logistics of setting up a joint regime comes up as a significant obstacle again and again. John Prust, sales and marketing director of Southern Pacific Mortgages, says: “The coverage of seconds would involve an enormous amount of further discussion and consultation.”
The voices of dissent will not go away, however. Iain MacQueen-Sims, director of audit company CheK Limited, says: “This represents a fundamental breakdown in regulation. The bulk of the seconds will come under the CCA. To have different regulators is completely mindless.”
But those in the market do not agree that we will see a spate of unregulated brokers.
“Second charge loans are not something that you can dip in and out of,” says SPML's John Prust. “Brokers who deal in seconds depend on up-to-date lender and product knowledge.”
The concern about the cowboys, however, will not go away. Bob Riach, proprietor of Riach Independent Financial Advisors says: “Regulation will certainly prevent some advisors taking on trainees and allowing them immediately to give advice to the public. But it is inevitable that the cowboys will go down the second charge route, at least until they can pass their exams. There is no doubt that they can make a living there.”
The market feels that the influence of the cowboys needs addressing. Barrie Jeffrey, partner with Trinity House Mortgages, says: “We cannot say how many cowboys are in the industry but until that figure is nil, we will not be able to fully restore our reputation. We need a clean and simple system.”
While the industry does need to address the probable effect of a significantly upgraded CCA, it would take a brave man to prophesy the magnitude of the disruption. Richard Hall, managing director of Best Advice Mortgage Centre, says: “With regulation, many brokers will become unauthorised, but they will not wish to see their incomes disappear. When financial services became regulated, many advisers were forced out into the mortgage industry. Brokers will now be forced out into the seconds market. My view is at least two in every 10 brokers will either illegally place mortgages or move into seconds. In financial services, the figures finally shrank by nearly 75%. Perhaps the 80,000 or so in our industry will eventually shrink to under 30,000.”
Some see a possible fundamental change in the structure of the market. Gerry Bell says: “It could be that we will end up facing two different broker markets. We may have mortgage brokers and finance brokers.” He feels that brokers might react by centralising the lending at the front end with the consumer. He continues: “Financial services could be a model. There will be more information to impart and confirm, and this is going to add to costs. Will the broker be able to afford those costs?” The proposed changes may affect the very structure of the industry. As Andy Murnaghan, head of mortgages at HSBC points out: “Mortgage lenders will need to consider their position in the second charge market. Effectively, they have to ask themselves if they want a second regulator (although, to some extent this does apply today). They may certainly take a view that they will concentrate on first charge lending and leave second charge borrowing to others who can specialise.”
The danger is that the market in seconds will increase, but not necessarily to the benefit of the consumer. The broker who might recommend a re-mortgage now could quite well be saying something different by January. Simply stated, the danger is that lack of clarity over second charge loans could drive brokers into the CCA sector to avoid regulation.
And there are those from whom we hear the authentic voice of doom. Ray Boulger of Charcol is adamant: “There is absolutely no doubt that the cowboys will migrate to product areas that do not require regulation. It was exactly the same with the financial service sector. There will be a huge amount of mis-selling.”
The growth figures are convincing. Secured lending from 1998 to 2000 almost doubled. Datamonitor predicts this overall trend is to continue. Loan size is growing with the average advance up from £12,000 in 1998 to over £15,000 in 2000 and this prediction has its supporters.
“Despite the advent of flexible mortgages the market is still growing,” says FNMC's Gerry Bell. “The market in seconds for 2002 will be of the order of £14bn. By 2005 we think the market will be of the order of £16.5 to £17bn. It is not possible to look beyond 2005. But with house-price inflation people will always want to borrow money.”
Clearly the second charge mortgage market is a specialist market and this will not change. About 10% of intermediaries do second charge mortgages but, as Richard Hurst says, it is a different regulatory body and the mindset is the problem.
“The second mortgage should have more exposure to the intermediary market,” he says. “It is a good product, particularly where speed is required. Conventional brokers need to add it as an option to their range.”
Television advertisements will continue to target the housewife at home and, as Mark Graves, managing director of Mortgages Direct says, the message is that you can appear to get anything you want as long as you are a house owner.
“With debt consolidation, people frequently have three or four credit cards. But when I rearrange someone's finances, I cannot stop them going out and doing it all again,” he says. “People are simply chunking away at their equity in their house.”
Current practitioners feel that there will be an orderly increase in this sort of product. Robert Owen says many more IFA's will add secured loans to their product armoury. “They will be able to offer their clients a comprehensive range of financial options.”
But perhaps one should not expect too much high-street penetration. As Bob Kujawski, seconds manager at Southern Pacific Personal Loans (SPPL), says: “We may see high-street lenders attempt to move into the niche market, but in reality they are not nifty enough.”
The expansion theory has other supporters, too. Gordon Taylor, business development manager at SPPL, says: “The market will increase in size. There is a valid position for it. Debt consolidation is a large part of the market and this route is quick and, in the short term, relatively cheap.”
If there is a threat, it is seen as coming from flexible mortgages.
One voice sounding the death knell of the seconds market comes from Jim Gillespie, principle of Independent Financial Services. He says: “The big competitor is flexible mortgages. Many clients do not have a need for second charge. The facility on the flexible mortgage is more than sufficient. This is a far more sensible route. The lender does not want to know the details.”
Phil Jay, BDS mortgage desk operations director, shares this view. He says: “Over the next five years I see an increase in flexible mortgages and this will cause the seconds market to stall, or even decrease.”
But he goes on to make a much stronger point on regulation. He says: “The seconds broker is going to have to justify his existence. But if you are not a qualified broker, then you should not talk about seconds if you cannot talk about firsts. How can you tell the consumer that this second mortgage is the way to go?” Other considerations may also affect the continued growth of the seconds market. David Hanratty, Investment Planning Director at Nelson Money Managers says: “Many use a second charge to support bank guarantees. This is traditionally on business proposals. Banks will not ease off attacking this equity.”
But there is another aspect.
“Most first mortgage deeds give power of veto over a second charge,” he says. “But property may fall in value. They will not want to scrabble over an asset if it falls in value. Therefore, the first mortgage holder will take a view over the asset. Lending policies may change. Today, a second charge is an automatic 'yes'. This could change to an automatic 'no' if we see price slippage.”
There is a corollary to this. He says: “Because the second charge is tied up with business lending the big commercial lenders want to keep the FSA out of their commercial activities. Effectively they are saying it is a business transaction and not a personal one.”
There are perhaps other constraints on business. Bill Petrie, mortgage development manager at Towry Law, says: “Inevitably, people with loads of equity will pile into them big time. And particularly if people only want to borrow a small amount, say £5,000. I can see the market increasing. But we are swamped by current business. Perhaps this will place a restriction on those who might consider operating in the seconds market.”
This internal expansion is confirmed by Bob Kujawski. He says: “Our business could double or treble – conservatively – over the next five years. There will always be adverse credit. More and more borrowers are finding themselves with an adverse record. It could even be something as simple as a missed mobile phone bill payment.”
There are, however, those in the market who see little change. LMC's Robert Owen says: “I see the second charge mortgage staying at the same levels really. I think it's a very discrete niche. It is a small element, much smaller than the credit card lending and probably much smaller than unsecured loans. But it does serve a purpose.”
And although many predict strong opposition from flexible mortgages, some caution may be required here. As Ray Boulger says: “As flexible mortgages become more popular, they will take over. This could be some 10 years ahead, but nevertheless it will reduce the requirements for second charge.”
Market expansion for the broker would appear to be relatively simple. In the view of Gordon Taylor, there is very little requirement for the broker to pursue the market as it will come to him. He says: “There are a number of sources including off-the-page advertising, or sub-brokers introducing business to larger brokers. Also the internet is being used to source business. Brokers can also buy mailing lists. The big credit agencies could sell out some of their information since they have good access to current market data.”
Huge changes are underway including regulation of first charge and an amended CCA for second charge. The administrative headaches concerned with bringing in first charge regulation are significant. It is imperative that this is not a botched job. Whether mortgages and credit should be regulated together or separately needs more discussion. But further modification may be required in a few years time.
So, was it nonsense or nouse on behalf of the Treasury? Or was it just playing the game with a very straight bat? The jury will be out on this for a few years yet, but even when it returns, it is unlikely that there will be a unanimous verdict.
The 'typical' customer doesn't exist
It is quite clear that there is substantial divergence in the profiles of consumers applying for second charge loans.
At Southern Pacific Personal Loans (SPPL), it is likely that their borrowers have been refused a loan from most high-street lenders for a variety of reasons. Their borrower is typically in his or her 30s to 40s, and will not necessarily be from any particular social group. They may be self-employed, they may have missed a couple of mortgage payments within the past six months, or they may have had credit difficulties that are now behind them. They might earn their income from numerous jobs or other sources, or they may be the sort of person which tends to receive large, lump-sum income payments as bonuses.
But the major problem is with first mortgage arrears.
If they have been refused credit from a number of outlets before they were referred to SPPL, they may need to raise the finance very quickly. Therefore, speed is of the utmost importance.
Gordon Taylor, business development manager for SPPL, says: “Most lenders will not deal with anyone below 21. Some lenders raise this limit to 25. The average age is probably someone in their 30s. The average size loan is about £19,000.”
Ocean Finance believes that, contrary to popular opinion, second charge finance is not just for poor people. The average family income of their borrower is now somewhere between £40,000 to £50,000 per household. Second charge loans up to, and over, £40,000 are now commonplace. The clients tend not to be professionals and are mostly managers, self-employed people, and even manual workers.
At the London Mortgage Company (LMC), borrowers are now up to seven years into their first secured mortgage. Borrowers do not want the second loan added to their first mortgage. LMC likes to deal with this type of expenditure in a different way and thus borrow for a specific purpose, preferring a flexible payment term that has a different term to the main mortgage. This is a critical point for many borrowers, as these people may or may not have impaired credit. The average size of loan is in the region of £12,000-£15,000.
At SPPL, the main purpose for the loan is debt consolidation. However, the customer may want to raise finance for a variety of purposes. These include car purchase, raising finance to meet some unexpected costs, long-planned home improvements, or a combination of the above. The average size of loan is £16,000-£17,000 and some 70% of personal loans are settled early.
The CCA – “an Act of extraordinary length and complexity”
The Consumer Credit Act 1974 (CCA) regulates credit agreements. Its main impact is on loans of up to £25,000, and it affects most mortgage lending in some way:
A: Advertisement regulations, including how annual percentage rates (APRs) are disclosed to reflect total charges throughout the life of the loan.
B: Requiring that warnings such as “Your home is at risk if you do not keep up repayments on a mortgage or other loan secured on it” be shown in all pre-contractual information on mortgage offers.
C: Charges by credit brokers limited to £5 if an introduction does not proceed to completion within six months.
Local trading standards departments and the Office of Fair Trading enforces the Act.
Licences are issued only if the OFT is satisfied that the applicant is a 'fit person' to hold one. They take into account anything considered to be relevant to a person's fitness, in particular evidence of fraud, dishonesty, or business practices that are oppressive or improper.
Each year, the OFT issues several thousand new licences, and the public can check whether a trader has a licence, or has ever applied for one, in the Consumer Credit Public Register.
The Consumer Credit Act implements the European Directive on Consumer Credit. The European Commission has published proposals for 'modernising' the Directive. The EC announcement says that lenders will gain improved opportunity to assess borrower risk, but in return they will be subject to “know thy client” obligations before granting any credit. Consumers will also have the right of withdrawal within 14 days, free of charge and without having to give a justification.
Time for a change
A major concern is that any new legislation should complement and not duplicate the mortgage rules currently being developed by the FSA. Objections include:
A: At present, it is far too easy to obtain a licence and far too difficult for the OFT to take a licence away once granted.
B: The CML would welcome more stringent entry provisions, in the form of some 'fit and proper' testing.
C: There are no effective sanctions other than revocation of a licence. This decision is thus taken only in extreme circumstances. There is room for other sanctions. Conditions could be attached to licences.
There is a logic to bringing all second mortgages within the scope of CCA regulation without limit, mirroring the approach taken by the FSA in relation to first charge mortgages (where no financial ceiling applies).