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Thinking Cleary: Get prepared for consumer credit rules

Alan Cleary, managing director at Precise Mortgages, casts a critical eye over the industry

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I wrote about second charge lending in Mortgage Strategy last month and how the regulation of second charges may evolve over the coming months and years. Many of the rules in the Mortgages and Home Finance: Conduct of Business sourcebook will be read across into the Consumer Credit sourcebook because, ostensibly, a second charge loan is the same as a first charge loan.

I have spoken to many colleagues in the industry about how they plan to react to the transfer of consumer credit into the FCA and, as you would expect, there are several schools of thought. Some believe that because the Office of Fair Trading regime has been carried across (pending implementation of the Mortgage Credit Directive in 2016), they do not have to do anything differently. I believe that view to be incorrect.

This is an extract from FCA policy statement PS14/3: “From 1 April 2014 all consumer credit firms must comply with our high-level standards: the principles for businesses, the relevant systems and controls rules and some general provisions including status disclosure rules.”

This means lenders – principals and networks – master brokers and brokers should react immediately. They should not wait for a change in the rules because the FCA’s Principles for Businesses have taken effect already. Here is a reminder of those principles:

1. Integrity – A firm must conduct its business with integrity.
2. Skill, care and diligence – A firm must conduct its business with due skill, care and diligence.
3. Management and control – A firm must take reasonable care to organise and control its affairs responsibly and effectively, with adequate risk management systems.
4. Financial prudence – A firm must maintain adequate financial resources.
5. Market conduct – A firm must observe proper standards of market conduct.
6. Customers’ interests – A firm must pay due regard to the interests of its customers and treat them fairly.
7. Communications with clients – A firm must pay due regard to the information needs of its clients, and communicate information to them in a way which is clear, fair and not misleading.
8. Conflicts of interest – A firm must manage conflicts of interest fairly, both between itself and its customers and between a customer and another client.
9. Customers: Relationships of trust – A firm must take reasonable care to ensure the suitability of its advice and discretionary decisions for any customer who is entitled to rely upon its judgment.
10. Clients’ assets – A firm must arrange adequate protection for clients’ assets when it is responsible for them.
11. Relations with regulators – A firm must deal with its regulators in an open and cooperative way, and must disclose to the appropriate regulator appropriately anything relating to the firm of which that regulator would reasonably expect notice.

For second charge lenders, responsible lending and treating customers fairly should be at the forefront of decision making and product design.

For brokers, second charge loans should form part of their product toolkit. For example, intermediaries should consider whether a second charge is a better solution for a customer than a remortgage or vice versa.

Here are some of the steps firms can take to ensure they embrace regulation and do the right thing by their brokers and borrowers:

  • Affordability – borrowers who apply for a second charge loan have to pass our affordability model which includes a stress for future interest rate rises of 2.78 per cent above the higher of the pay rate or revert rate of the loan.  This is likely to be increased to 3 per cent as a result of the Financial Policy Committee’s recent announcements.
  • We also stress the borrowers first charge loan for future rate rises.
  • Verification of income – we apply the same logic for seconds as we do for first charge, that is, P60s, payslips and bank statements for employed and certified accounts/SA302s and bank statements for self-employed. 
  • We have loan-to-income caps that control the maximum loan a borrower can qualify for in order to ensure the loan is responsible and that the borrower can afford to pay it back.
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As with any change, there will be a period where we all have to learn new things and adapt our behaviours and some will find this more painful than others. For example, this is a real-life scenario I discussed with a mortgage broker last month: the master broker has placed a second charge loan with a lender which charges a relatively high rate – say 10.4 per cent a year. There is a lower-priced product on the market for which, on the face of it, the borrower would qualify at 9.45 per cent a year. When asked why the deal was placed on the more expensive product, the master broker said the lender had no LTI caps and therefore the borrower might be able to get a bigger loan. It would also be easier to place the case because the master broker would not have to worry about the LTI cap.

This is a questionable decision for the following reasons:

  • Did the master broker make sure the borrower did not qualify for the cheaper product?
  • Did the borrower need a bigger loan than that they had applied for?
  • LTI caps are there for a reason and lenders who do not use them may not be acting responsibly.
  • The amount of work the master broker has to do is irrelevant because the regulated broker should advise the best product for the customer, not the easiest one to process.
  • If the borrower complains in five years time that they have paid £1,500 too much interest, what is the likely outcome?

Although this master broker may be able to make the claim consumer credit rules are there for guidance purposes and that the full rules will not be implemented until March 2016, this particular example would fail a number of the FCA’s principles.

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