No substitute for sound initial advice

Firms tend to deal with compliance reactively, not proactively. The latest notice from the Financial Services Authority or a headline suggesting regulatory attention drives their activity.

But there are signs that firms further down the compliance road are becoming more proactive. They’re tweaking their processes to further enhance their regime rather than having to un-dergo wholesale implementation.

And a few firms are taking their statutory obligations a step further when it comes to interest-only loans.

Rather than simply including the FSA’s stipulated wording in their communications with borrowers, some lenders are proactively ensuring their clients know exactly what interest-only is and the risks it entails. And of course, there are benefits to this besides getting into the regulator’s good books.

I recently spoke to the collections manager of a large loan firm in the US, who mentioned despairingly that several minutes of every call made by his staff was taken up by them delivering an idiot’s guide to mortgages to hapless custom-ers. Only by emphasising to clients the true severity of their situation could his team make any progress.

But there’s an implicit criticism of brokers in my US colleague’s anecdote. Why should his collections team be forced to explain mortgage products to customers who should have received that advice before signing up? And why should UK lenders have to adopt a similar stance?

A member of my staff recently told me that when looking for a buy-to-let mortgage he’d re-ceived some curious advice from a broker.

First he was told that a residential product would be the best option. On questioning the efficacy of a residential mortgage for a buy-to-let deal, the broker told him the rate was lower and the lender need never know.

Second, the broker also assumed from the start that my colleague wanted an interest-only deal. When asked about paying back the principal as well, the broker looked puzzled and point-ed out that it would be more expensive.

Crucially, the broker also made no mention of the difference between the methods of payment – namely that an interest-only deal would see the entire principal remain outstanding until the end of the term.

Good advice and sound underwriting form the bedrock of this industry. Brokers must give the best advice and lenders must sift out unacceptable risk. Although lenders can educate borrowers, no matter how pleasing this is from a compliance perspective, it’s no substitute for good advice at the beginning of the process. This advice must ensure that borrowers understand the features of their loans, particularly where interest-only is concerned.