One of the key areas for improvement identified by the FCA in its Mortgages Market Study final report is to make it easier for so-called 'mortgage prisoners' - longstanding borrowers on relatively high reversion rates (the interest rate that applies once any introductory rate ends) - to switch to new deals. It is therefore proposing changes to its responsible lending rules and guidance to introduce a modified affordability assessment for eligible consumers. Where lenders choose to take advantage of the new regime, many of the changes will mean a relaxation of the current affordability requirements to help set 'mortgage prisoners' free.
What's the background?
The FCA believes that post-financial crisis changes in regulatory requirements for affordability assessments and in lending practices left some consumers on relatively high reversion rates when their introductory deals came to an end. These 'mortgage prisoners' have been unable to switch to cheaper mortgages despite being up-to-date with their payments. Most 'mortgage prisoners' are with firms that are inactive and/or not authorised to lend.
A voluntary industry agreement among active lenders has already been introduced
Over 65 active lenders (around 95% of the market) have signed up to a voluntary industry agreement to help existing customers who previously didn't qualify for a switch to find a better deal via an internal switch, providing they meet certain minimum criteria. Lenders have already contacted qualifying customers to offer a switch to a better interest rate. The FCA will monitor what proportion of 'mortgage prisoners' have mortgages with the 5% of active lenders that have not yet signed up and keep the effectiveness of the agreement under review.
Proposed changes to the FCA's responsible lending rules and guidance in MCOB will tackle the more complex issue of 'mortgage prisoners' with inactive firms
For 'mortgage prisoners' with inactive firms who are not looking to borrow more, the FCA is proposing changes to its current responsible lending rules and guidance to remove regulatory barriers for lenders who might be willing to lend to these customers. The existing affordability assessment will be retained, but lenders can choose to carry out a modified assessment for these customers, provided that they can demonstrate the new mortgage is more affordable than the customer's present one.
Who will be eligible?
The FCA proposes that eligible consumers must meet all of these criteria:
- Be up-to-date with payments on their current mortgage for the 12 months immediately before their new mortgage application
- Not want to borrow more, other than to finance any relevant product or arrangement fee for the new mortgage
- Be looking to switch to a new mortgage deal on their current property, although the FCA is seeking views on whether the modified assessment should also be available to those looking to switch to a new mortgage deal on a different property (eg downsizing)
What does 'more affordable' mean?
The proposed definition of 'more affordable' mortgage differs depending on whether any product or arrangement fees have been added to the mortgage or the consumer is paying for them upfront:
- Fees added to the mortgage: the new mortgage must have both a lower interest rate and lower monthly payments during the introductory deal period (or the whole term if there's no deal) than the existing mortgage.
- Fees paid upfront: the total expected cost of the new mortgage during the introductory deal period (or the whole term if there's no deal), including the fees paid upfront, must be less than the consumer would have paid on their existing mortgage over that time and the new mortgage must have a lower interest rate during the introductory deal period (or the whole term if there's no deal) than the existing mortgage.
The FCA thinks it's important for lenders to bear in mind, when assessing affordability, that when consumers pay relatively large fees upfront this can significantly increase the short term cost of their mortgage without being reflected in the monthly payment.
The FCA is also asking for views on adding another condition to its proposed definitions of 'more affordable' that brings in the existing reversion rate of the new lender, but it acknowledges that this could restrict participation by some smaller or specialist firms. It is also not proposing to restrict the revised affordability assessment to consumers on a reversion rate.
Worked examples of the proposed definitions are provided in Annex 1 to the consultation. However, it's not clear from the FCA's examples how, in a scenario where there is no introductory interest rate under the new mortgage and the applicable interest rate would be variable, lenders would be able to establish with any certainty if such rates under the new mortgage would definitely be lower than the current rates throughout the new mortgage term. The FCA's proposed new guidance only provides that references to future payments or interest rates in the new rules should be taken to be on the assumption that there is no variation to the reference rate in question unless the mortgage contract expressly provides for a variation. It gives the example of a lifetime Bank of England base rate tracker, where it should be assumed that the Bank of England base rate won't change.
What about extending the mortgage term to make it more affordable?
The FCA doesn't think it's necessary to ban term extensions, even though it means that consumers could end up paying more overall. However, it proposes a requirement on lenders to make this point clear to consumers. If the new extended term would take the consumer past their anticipated retirement age, the FCA also proposes a rule to require lenders to consider income in retirement.
Lenders will be able to disapply some existing MCOB rules and guidance
The FCA intends to allow lenders that choose to use the modified assessment to disapply certain of its existing MCOB rules and guidance in relation to:
- income and expenditure – Lenders can still choose to apply these rules and the FCA proposes new guidance so that lenders can take into account the fact that the consumer is up-to-date with payments and moving to a more affordable mortgage;
- future changes to income and expenditure – As mentioned, where the new mortgage would extend into retirement, the FCA proposes a new rule requiring lenders to consider whether post-retirement income would be sufficient to meet the consumer's mortgage commitments. The FCA also proposes new guidance that lenders should take a prudent and proportionate approach to assessing post-retirement income;
- interest rate stress testing - Where lenders do choose to carry out some form of stress testing, new guidance is proposed to take account of the fact that the consumer is currently meeting payments on a higher rate than on the more affordable new mortgage;
- interest-only mortgages – However, existing rules and guidance would still apply where consumers want to increase the proportion of the loan on an interest-only basis or they're looking to move from capital repayment to interest-only. Lenders would also still be required to review any interest-only mortgages in line with current MCOB requirements.
New disclosure and reporting requirements
Lenders that make use of the modified affordability assessment will be subject to new disclosure requirements, including a requirement to disclose to consumers the basis on which their affordability has been assessed and to provide some additional disclosures about potential risks. New and revised reporting requirements will also apply when submitting Product Sales Data reports.
New one-off consumer communication requirements for some firms
The FCA is proposing that inactive lenders and administrators acting for unregulated firms will be required to review their customer books to identify eligible consumers and write to them highlighting the rule changes outlined above and that they may be able to switch, and directing them to further information. This is a one-off requirement, to be carried out within 13 months of introduction of the new rules.
What about active lenders?
For active lenders, given that not quite all of them have signed up to the voluntary agreement on switching, the FCA proposes to restrict the use of the modified assessment to those that operate a policy for offering existing customers the ability to switch to a more affordable mortgage product. The FCA thinks this should help customers of active lenders who might need to switch again to avoid a higher reversion rate than they would otherwise have been on.
Proposed changes to mortgage reporting requirements on mortgage books sold to unregulated firms
In its Mortgages Market Study final report, the FCA states that it wants to improve its knowledge of consumers whose mortgages are with unauthorised firms, and has therefore consulted on changes to its mortgage reporting requirements on mortgage books that have been sold to unregulated firms. Final rules are expected this summer.
For more on the FCA's other findings in its Mortgages Market Study final report, take a look at our blog 'Mortgages Market Study: FCA's final report puts consumer information, innovation and freeing 'mortgage prisoners' front and centre'.
The FCA's consultation on changes to its responsible lending rules and guidance closes on 26 June 2019. It plans to publish a policy statement with final rules and guidance in Q4 this year.