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Dangerous liaisons

With the focus on the potential for sub-prime mis-selling, brokers will have to take steps to protect themselves from client complaints and increasingly cannibalistic fellow brokers, says Harvey JonesWith the focus on the potential for sub-prime mis-selling, brokers will have to take steps to protect themselves from client complaints and increasingly cannibalistic fellow brokers, says Harvey Jones

Given industry paranoia about mis-selling, the Financial Services Authority’s probe into the deficiencies of smaller brokers in the sub-prime market was always going to set nerves jangling.

As part of its compliance review, the FSA visited 31 small brokers and found too many companies couldn’t show whether their recommendations were suitable to their clients’ circumstances. In six out of 10 cases the adviser hadn’t taken enough information in key areas, while in eight out of 10 cases they failed to assemble sufficient evidence to show how their advice met customer needs. The FSA subsequently identified sub-prime as “a priority area for our mortgage supervision”.

Grim tidings, and advisers who believe they are immune to complaints are misguided, says Kevin Paterson, national sales director at Park Row Associates. He believes the increasingly cannibalistic culture of the financial services industry means any broker could find themselves being prepared for the pot.

He takes as an example a client who has been sold a sub-prime deal, then has to remortgage six months later due to further bad debts.

“Leopards don’t change their spots,” he says. “Borrowers who have faced financial problems in the past are likely to run into trouble again. Many will be too embarrassed to go to their original broker and will try someone else. That’s when the trouble starts.”

That client’s original deal was likely to have a three-year overhang and early redemption charges running into five figures. “The new broker will tell them it could cost 12,000 to get out of this deal but if you file a complaint against your previous broker they could pay it for you,” he says. “Some brokers will even offer to write the letter, a lot of that stuff goes on.”

“You have to remember that sub-prime business lends itself to complaints, especially now we have created this cannibalistic culture that encourages clients to complain about brokers.”

Advisers who don’t protect themselves could end up on the FSA chopping block. “Your advice may be correct but if you can’t show this you’re in trouble,” Paterson adds. “If you didn’t write it down, it didn’t happen. And these won’t be small ticket claims. If a broker is earning between 2% and 4% on a mortgage with a three-year penalty, repaying those fees will be costly.”

Ray Boulger, senior technical manager at John Charcol, says any adviser approached by somebody who recently arranged a mortgage with another broker should tread carefully.

“Monthly repayments in the first year of their new deal should be fairly low so if the client is struggling they have a serious problem,” he says. “I would tell this client to go back to their initial broker and ask them to justify their recommendation.”

Boulger notes that this is the second FSA mystery shopping exercise in a matter of weeks, following fast on the heels of the probe into equity release sales. He sees a pattern emerging.

“Neither report criticised the actual advice but focussed on advisers’ failure to provide sufficient information to Gjustify their recommendations,” he says. “This doesn’t mean we should assume all the advice was good but if it was really bad, the FSA would surely have commented.”

The FSA has admitted it couldn’t establish the level of consumer detriment or potential mis-selling as many failings related to poor record-keeping, and brokers could provide more detail when challenged.

It plans a further review of small firms in the sub-prime market early next year and Boulger says it is clear what brokers must do now.

“Being correct is no longer enough, you have to prove it,” he says. “Take endowments. Many advisers accused of mis-selling probably got their advice right but had no way of showing that.”

Doing a thorough fact-find and documentation is a good discipline, he says. This should also reveal whether your advice was incorrect.

Two advisers asking the same client the same questions may justifiably recommend different products.

“Their decision will inevitably reflect their personal views,” Boulger says. “Both may be absolutely right and I am sure the FSA understands that, but both brokers need to justify their decisions.”

The FSA has referred three brokers to enforcement for further investigation, after they appeared to help clients inflate their incomes to meet lenders’ criteria. But mystery shoppers and cannibalistic brokers aren’t the only threats facing advisers.

Lenders will be determined to maintain their own good name in the face of a marauding FSA and may be tempted to shop brokers to the regulator.

“Lenders who spot serious deficiencies in business submitted by a broker are increasingly likely to report that to the FSA,” Boulger says. “The relatively small cowboy element among brokers will find the regulator comes down on them quite hard. Brokers should welcome that because a few cowboys give everybody a bad name.”

But advisers must stand their ground if they feel the FSA has gone too far, particularly if they have recommended consolidating short-term unsecured debt into long-term secured debt.

“The FSA clearly doesn’t appreciate that paying the debt over a longer period may be absolutely the right advice if it stops the client defaulting, particularly if the mortgage has a lower interest rate,” Boulger adds.

The broker must explain to the client that borrowing money over a longer term may cost them more.

“But they won’t necessarily pay all the interest,” he says. “After all, the average mortgage lasts around four years. When the client gets back on the straight and narrow they can accelerate repayments – some sub-prime deals even allow 10% annual overpayments. The FSA shouldn’t automatically assume it’s wrong to switch to long-term debt and advisers mustn’t be browbeaten into giving advice they don’t think is correct.”

Ian Giles, marketing director at Purely Mortgages, describes sub-prime as “a hole in the market that the FSA has yet to efficiently plug”. But it won’t be gaping for long, he says.

“Both the FSA and its political masters fear they will be slammed if serious problems emerge.”

Currently, the higher margins on sub-prime business give small, specialist brokers an unfair edge when competing for business.

“Sub-prime isn’t a level playing field,” says Giles. “Brokers can take anything up to 3.5% in commission, which gives them a healthy marketing budget to attract the next customer. They can spend money on online and direct mail advertising. Brokers who charge lower fees simply can’t compete.”

Sponsored links on major search engines don’t come cheap – advertisers can pay 10 to 15 for every click-through.

“If only one in 10 leads to business the sub-prime broker still makes a healthy margin,” Giles says.

Smaller brokers often use the same lenders as big names such as Purely Mortgages, London & Country and John Charcol.

“We all use BM Solutions, Kensington, GMAC-RFC, Platform, but we charge 195 and smaller brokers charge up to 3.5%,” Giles says. “On a 100,000 loan, that’s 3,500. Same advice. Same product. Different pricing.”

This exploits the most desperate and vulnerable customers by charging the highest fees to those least able to afford them.

“Brokers have got away with this because sub-prime is a small, niche, little understood market,” says Giles. “It doesn’t attract much attention from personal finance journalists so customers don’t find out about the dodgier practices. If more people walked into their adviser’s office clutching a newspaper article and asking tough questions, advisers might work harder to get more compliant.”

Too many present sub-prime as a black art. “They say it won’t be easy, but I know somebody who might help,” says Giles. “This is ridiculous, when Trigold can deliver a decision in minutes or even seconds. The FSA has started cleaning up the sector which should help make the playing field level and force high-charging brokers to think twice.”

Cath Hearnden, joint director at My Mortgage Direct, says another problem is that many sub-prime brokers automatically channel clients to specialist lenders even if they might get a sympathetic hearing on the high street.

“As more mainstream lenders enter sub-prime, there is more pressure on brokers to do this,” she says. “Lenders that might have taken a light adverse client onto a mainstream product one year ago now automatically downgrade that application to sub-prime.”

This has been aggravated by the move toward online applications. “Some brokers find it easier to go sub-prime rather than fight their client’s corner but if they could have given them a mainstream product they could run into trouble with the regulator,” Hearnden says.

Lenders aren’t the only ones who might get brokers into trouble. Clients can prove tricky themselves, says one broker who asked not to be named.

“Clients with heavy adverse credit aren’t always truthful,” he says. “They are either embarrassed or not bothered about being honest. You have to dig deep or you might recommend the wrong product because you haven’t got all the information.”

Marc Turner, head of sales at Abacus Permanent, says brokers must protect themselves by asking all the relevant questions on affordability, matching the product to the client’s circumstances, clearly explaining any early redemption charges and then writing it all down.

“Intermediaries cannot be held responsible for a customer’s poor credit habits provided everything has been correctly documented.”

Brian Murphy, lending manager at the Mortgage Advice Bureau, suggests brokers who are wary about sub-prime could allay their fears by working with a specialist packager.

“We take all the client’s details and examine some of the likely products, then run that past the packager, who credit scores the client and maybe suggests two or three other deals or offers them an exclusive. That way we know they are getting the right deal,” he says.

But Paterson says brokers must use packagers carefully because they will pay the price if they devolve too much responsibility.

“Brokers with limited experience in sub-prime often ask a packager to advise on the product but they still hold ultimate responsibility,” he says. “In most cases, the audit trail will end at the packager, leaving the broker exposed. Many haven’t taken this into account.”

Park Row protects itself by working with only one packager. “We work together on best practice and share access to back-office systems and advice processes,” Paterson says.

“Both compliance departments talk to each other, which gives total transparency. The audit trail comes right into the packager’s premises so that if a client complains we can pinpoint exactly what went wrong. Most brokers aren’t doing this and are running a huge risk.”

Sean Hornsby, managing director of Mortgage 2000, says provided brokers stick to a compliant sales process, keep good records and back their recommendation with a reasons why letter, they have nothing to fear from sub-prime complaints.

“They must also be able to show they have continually researched the market, and, if using a panel, have declared this to the client,” he says.

Advisers must also consider the alternatives to a mortgage. “Best advice isn’t just about price but matching products to clients’ circumstances,” Hornsby says. “For debt consolidation, a secured loan may be a better option. Sourcing systems such as Mortgage 2000’s Encore allow intermediaries to compare the total cost of a product over a specific term.”

Martin Reynolds, head of sales at BM Solutions, says it is important to remember the FSA probe dealt with a small sample of small companies making up a tiny proportion of the industry.

“This type of report invariably generates doom-mongering in the industry but to claim the findings will lead to the next big mis-selling scandal is a knee jerk reaction.”

And the industry should take on board the positive as well as the negative. “The FSA found that 58% of companies intended to review their client’s product once their credit record had rehabilitated and 65% confirmed their standard practice was to issue suitability letters outlining the reasons for a recommendation,” he says.

This goes beyond MCOB and suggest malpractice is less common than many claim. “After all, not even the FSA, expected the industry to enter regulation without teething problems,” Reynolds says.

The sub-prime sector provides an excellent service to consumers who have suffered financial blips.

“But we should still heed the FSA’s warning shot and focus on what can be done to make sure the image of this sector, which many have worked hard to improve, isn’t tarnished,” he adds.

Jeff Knight, head of marketing services at GMAC-RFC, says intermediaries shouldn’t be afraid of sub-prime.

“Consumers appreciate the benefits of this product in terms of home ownership and the chance to rehabilitate bad credit. Sub-prime also has an important role to play in getting these borrowers back into the mainstream.”

The rise of the sub-prime market has been terrific news for home owners with credit problems, allowing many to hang onto their homes and steer clear of loan sharks.

Brokers, lenders and the FSA now have a duty to make sure advice is up to scratch without jeopardising that success.

New players mean better deals for sub-prime clients in the future
Linda Will is managing director of Accord Mortgages
As a new entrant to the sub-prime mortgage market – and still only in pilot mode with six key partners – Accord Mortgages does not have the experience of pre-Mortgage Day sub-prime business to inform our comments. But we have researched the market thoroughly, have spoken to some of our new competitors who have been frank about their experience and have also been able to draw on broker opinion as a result of our nationwide series of focus groups, now in their third year.

So, has there been mis-selling in this marketplace in the past? Feedback from all the sources suggests that not every credit impaired customer has always been offered the best possible value. For example, the number of cases in the medium, heavy and unlimited segments have, according to some, decreased significantly. This became evident almost immediately after mortgage regulation came into effect. It could, of course, be a coincidence but the fact that many more clients have only light levels of impairment is supported by the growth in the number of near prime categories that have proliferated in recent months. It’s only a matter of time before we see a category called ‘I can’t believe it’s not prime’.

In focus groups, brokers have talked about some packagers who always seem to recommend lenders with long overhangs and less than razor sharp rates. This is not an attack on packagers – many brokers have sung the praises of companies that have helped them place difficult clients with consummate skill but nevertheless, some have perhaps been influenced by factors other than the borrower’s best interests.

Then there is the product design process itself. For a number of years a borrower who had stained their credit history was sentenced to significant loadings and long overhangs tying them in for years. If they did figure out that they could do better elsewhere, the profit margin was still insured through hefty redemption penalties. Perhaps it is the rash of new entrants that has forced the pace in product improvements but competitive pricing and no overhangs are becoming standard.

Whether clients have been misadvised in the past will, no doubt, become clear in time. But the good news is that increased competition, improved sourcing systems, online decisioning, product cascading and innovation will ensure a much better deal for sub-prime borrowers in the future.

In my ideal world all brokers would be DA and have access to all deals
Gary Dixon is managing director of compliance.co.uk
The majority of complaints in the mortgage industry will be prompted by information provided by the next broker.

Customers are increasingly switched on about financial products but brokers are predatory when it comes to getting in new business. This has been happening across the whole financial services arena for many years, not just the mortgage industry. There is a tendency for the new adviser to use hindsight and say: “You shouldn’t have had that deal”.

We have seen this in the investment market, when investments have gone down. In the future, we will still see it in the sub-prime arena.

But it is always the case that only the consumer can complain. While they may have been primed by a broker, they are the only ones who make the complaint to the regulator.

The problem is that there are so many deals out there that brokers can never hope to consider all of them.

There will always be someone with excellent hindsight who will say “you should have had this or you should have had that”.

Most brokers are appointed representatives and don’t have access to the whole of the market. There will always be restrictions if you have two-thirds of the market as appointed representatives.

Brokers can take steps to protect themselves from complaints. In my ideal world, all brokers would be directly authorised and have access to the whole market. Technology also provides restrictions as you can only provide timely information to an extent and this is a very fast moving market.

Brokers can write to consumers, explaining the considerations they have been through and why they have chosen a certain option. It is rare for a broker to say: “This is the only product for you”. Instead they often suggest several options and leave it to the consumer to make the final choice. Record keeping is vital.

Brokers should focus on after-sales service
John Webster is managing director of Preferred

There’s nothing unusual about a customer requiring a further loan but if they do, they should always see whether there is a further advance or second charge option available instead. A borrower may not need to remortgage and so incur the early repayment charges associated with redemption of their first loan.

Intermediaries have an obligation to borrowers to fully explain the products being offered and ensure clients understand the financial commitment they will be taking on, including the impact of any early repayment or other charges attached to the loan. And they need to take the time to establish the customer’s ability to pay not only their mortgage payments but also their other bills and financial commitments such as credit and store cards.

The question about mis-selling also raises the importance of relationship management. Should an intermediary build customer after-sales service into their business process? Building in regular review meetings with customers makes good sense and is a win win. Borrowers have the reassurance that someone is looking out for them and ensuring they have the best possible products, and the intermediary can benefit as regular meetings may also provide the opportunity for additional sales. Offering this level of customer service also has the knock-on effect of obtaining referral business. Customers are usually happy to recommend a broker if they feel they have received a high level of service and advice.

Lenders can help brokers avoid mis-selling
Liz Sully is head of compliance at GE Money Home Lending
The financial services industry has had its fair share of mis-selling scandals and in recent weeks we have seen the media spotlight turn on the mortgage industry.

As a number of complaints regarding the selling of sub-prime mortgages start to surface, it is important to keep this so-called scandal in perspective. The latest claims of mis-selling highlight a niche but regulated area. It must be remembered the vast majority of companies work closely with the FSA to ensure they are operating in a fair, transparent and compliant way.

Intermediaries must spend sufficient time with clients to ensure they fully understand their needs and clearly explain the terms and conditions to ensure the customer has a good understanding of the loan. It is important they document the reasons for each recommendation and share these with their customers. It is through thorough training and guidance that we can ensure the selling of our products remains fully transparent.

We also help brokers avoid mis-selling by providing marketing and loan documentation in plain, customer-friendly language. It is vital to ensure borrowers are fully aware of all the key aspects of the loan they are considering. For example, not all customers will know that early repayment charges are common with sub-prime products and also with many fixed and discount products.

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