Second charge lending, previously only regulated under the Consumer Credit Act 1974, has now been moved into the FCA's remit and made subject to the Mortgage Conduct of Business rules. This article considers the key changes for second charge lenders both pre- and post-sale.
Prior to 21 March 2016 second charge mortgages were regulated under the Financial Conduct Authority's (FCA) consumer credit regime and the provisions of the Consumer Credit Act 1974 (CCA). In 2011 the UK government announced that it intended to transfer second charge mortgage regulation from the FCA's consumer credit regime into the FCA's mortgage regime, as it was thought more appropriate to regulate lending secured on the borrower's home consistently, regardless of whether it is a first or second charge. When the Mortgage Credit Directive (MCD) was transposed into UK law and regulation, the regulation of second charge mortgages was therefore moved into the FCA's mortgage regime.
Changes to second charge lending from March 2016
Many of the rules and guidance relating to mortgages contained in the FCA's Mortgages and Home Finance Conduct of Business sourcebook (MCOB) are now applied to second charge mortgages as the risks they pose to consumers are considered to be similar to those for first charge mortgages. Unless a provision is disapplied for second charge mortgages, most of the FCA's MCOB provisions will therefore apply. In addition, second charge mortgages will continue to be regulated under the CCA; in particular the following CCA provisions continue to apply to second charge mortgages:
- prohibition on interest being increased on default (section 93);
- right to complete payments ahead of time (section 94); and
- right to a rebate on early settlement (section 95).
The main changes introduced as a result of the extension of the MCOB rules to firms operating in the second charge mortgage market include requirements to:
- provide an adequate explanation of the mortgage loan's key features;
- issue a binding offer;
- provide a seven-day (minimum) reflection period; and
- provide prospective borrowers with a European Standardised Information Sheet (ESIS) disclosure document.
Some of the significant changes are set out in more detail below.
New rules for second charge lending
The rules in MCOB chapter 2 apply to second charge mortgages and to the second charge back book, although the FCA does not expect these requirements to have a significant impact on second charge lenders.
The MCD introduced significant changes to the disclosure requirements that firms conducting second charge lending were subject to, including the following:
- Service disclosure: Firms must make an initial disclosure to consumers which covers their scope of services and remuneration. The FCA also introduced a third service disclosure requirement to highlight the range of alternative borrowing choices that may be available (e.g. further advances on unsecured loans). These key messages must be clear and prominent, and if there is a spoken contract with the consumer they must be made orally. There is no prescribed format for this information.
- Product disclosure: Firms must provide consumers with an ESIS, which is a prescribed and standardised product disclosure document designed to help consumers shop around.
- Offer disclosure: As well as the MCD requirements, the FCA has applied the same offer stage requirements as for first charge mortgages. Therefore, in order to let consumers know in advance the standard fees that might apply to their mortgage, second charge lenders must provide a copy of their tariff of charges.
- Post-sale disclosure: Firms must comply with the same post-sale disclosure requirements as apply to first charge lenders, which apply to disclosure at the start of the contract, an annual statement, and certain event-driven information (e.g. where a customer experiences payment difficulties or a variation is made to their contract).
Advising and selling standards
Prior to 21 March 2016 all second charge mortgages were sold on a non-advised basis, therefore there was no concept of regulated advice in the second charge market. However, the same advising and selling standards as apply to first charge mortgages now also apply to second charge mortgages. As a result of this, execution-only sales are only allowed in limited circumstances (e.g. for non-interactive sales, some contract variations and some niche markets).
- Affordability: The MCD creditworthiness assessment, which is addressed through the MCOB affordability rules for first charge mortgages, now also applies to second charge mortgages. The FCA also made some amendments to reflect the nature of second charge lending.
- Considering the effect of future interest rate rises: The MCOB affordability rules, which require lenders to take account of future interest rate rises when assessing affordability, now also apply to second charge mortgages. Additionally, second charge lenders are required to stress test affordability for higher ranking secured loans.
- Debt consolidation: For second charge debt consolidation mortgages, lenders must either take reasonable steps to ensure the consolidated debts are repaid or include them in the affordability assessment if they were not repaid.
- Interest-only mortgages: Unless the FCA decides otherwise, the interest-only rules contained in MCOB also apply to second charge mortgages.
Second charge lenders must comply with the MCOB rules on contract variations relating to disclosure, advising and selling standards, and responsible lending. A lighter touch regime applies where a transaction does not involve further borrowing, which allows borrowers to choose to transact on an execution-only basis and for the lender not to undertake a further affordability assessment.
- Automatically rolling up fees and charges (e.g. lender and broker fees) into loans is prohibited, unless a customer has made a positive election to do so.
- The early repayment charges in MCOB apply to second charge mortgages. Back book second charge mortgages will remain subject to the early settlement provisions in the CCA (section 95).
- Firms are prohibited from imposing pre- and post-contractual charges on a customer and ought to follow the guidance in MCOB to help them determine whether a charge is excessive.
- The payment difficulties/arrears provisions in MCOB now apply to second charge mortgages and have replaced the previous consumer credit requirements in the FCA's Consumer Credit sourcebook (CONC).
- The previous regime in the CCA restricted second charge lenders in their ability to charge interest on default charges in three ways. It: prevented firms from charging interest on arrears until notice was given of those charges; required firms to provide the customer with a 29-day grace period to make payments before the interest was charged; and only permitted firms to charge simple interest on default charges, not compound interest.
There are no similar restrictions in MCOB; however, a new rule in MCOB only permits second charge lenders to charge interest on default charges on a simple basis rather than a compound basis. This also applies to the back book of existing loans.
The rules in MCOB chapter 13 dealing with payment shortfalls and the process to be followed for repossessions now apply both to new second charge mortgages and to the second charge back book for those second charge loans originated prior to 21 March 2016.