Mortgage market review
Last reviewed 23/06/2011: any recent updates in this colour.
This page contains information on the following:
Following the global financial crisis, the Financial Services Authority (FSA) announced that it would undertake a review of the mortgage market.
In February 2009, the FSA formally announced the mortgage market review (MMR) outlining that it would be a holistic review looking beyond conduct of business regulation stating that the review would cover 'the complete value-chain in the market (e.g. lenders, intermediaries and consumers), and will cover all aspects of regulation, including prudential, conduct of business, and financial crime.'
The FSA’s aim for the mortgage market review is to deliver a ‘sustainable market for all participants and is flexible for consumers’.
The CML supports the stated outcome of the MMR process and indeed the need for a review of all aspects of mortgage regulation to help deliver a sustainable and flexible market.
Looking at some of the detailed points within the MMR, the CML again, broadly agrees with the FSA that lenders are and should be responsible for assessing affordability. This includes the assessment of a borrower’s income.
Where we differ from the FSA is around the details of its policy and with the underlying principals that underpin the new approaches to conduct risk and consumer protection.
The CML strongly believes that the approach in the MMR's responsible lending proposals is likely to negatively impact on a broad range of credit-worthy borrowers, have significant impacts for all housing tenures and is now a political, as well as a regulatory, issue.
We have been calling for a clear view from the coalition government regarding its housing policy and the future of regulation and how mortgage regulation should reflect broader government policy.
Back to top
Conduct risk and the MMR: ‘protecting consumers from themselves’
The new approach to conduct risk, outlined in a speech by the FSA’s chief executive Hector Sants in March 2010, is one based on pre-emptive action to address detriment before it occurs.
This approach necessarily requires the FSA to make ‘judgements’ on what it considers to be unacceptable practices that are likely to result in detriment for consumers. The MMR is the first sector-wide application of this new approach.
In the MMR, the FSA’s judgements on detriment are based on a view that consumers in the mortgage market have not generally acted rationally or in their best interests and that regulatory controls are necessary to ensure that irrational consumers are protected from themselves by placing additional requirements on lenders.
Seeking to mitigate potential detriment through detailed conduct rules is likely to have significant and broad unforeseen consequences in significantly limiting legitimate borrowers access to the market.
Back to top
To protect consumers in this way it requires the transfer of responsibility from the consumer to the lender. This is demonstrated in the definition in the FSA’s definition of what is an affordable mortgage in its responsible lending proposals.
‘A mortgage is affordable if its level and terms allow the consumer to meet current and future payment obligations in full without, recourse to further debt relief or rescheduling, avoiding accumulation of arrears while allowing an acceptable level of consumption’.
On face value this may seem like a sensible definition, but it requires lenders to make a judgement on the borrower’s ability to make payments throughout the term of the mortgage.
This is translated into the draft rules for lenders where it states that a mortgage is unaffordable if any particular month that a borrower’s expenditure exceeds their income. The lender has to take into account the variability of income (impacting self-employed borrowers) and expenditure over time. For credit-impaired borrowers, up to 20% of their income could be discounted for this equation, to provide a ‘buffer’ for un-disclosed debts.
Equally, the FSA is proposing that the lender verifies future income where it is relied upon, where the mortgage extends into retirement this would necessarily capture income from pensions. If a borrower intends to continue to work beyond retirement age, the lender is required to make a decision if the borrower is reasonably capable of managing this.
Furthermore, the lender is required to use a number of assumptions when assessing the affordability this includes assessing all mortgages on a capital repayment basis, on a maximum term of 25 years and to stress test against potential interest-rate rises.
The overall outcome of these requirements is to create a number of layers of protection to ensure that the borrower can afford the mortgage in all foreseeable circumstances. For some of the requirements this is a straightforward calculation (e.g. capital repayment) for others it requires the lender to make a number of judgements on what events are likely to affect the borrower and allow for a sufficient reduction in lending to compensate.
It is the layering of regulation that is likely to restrict access to the mortgage market for a significant number of current and future borrowers. This will be exacerbated with a conservative approach adopted by lenders, due to the additional regulatory risk that they face in complying with the proposed new rules.
Back to top
Impacts of the MMR: The need for debate
Lord Turner reflected on the potential impacts of the FSA’s proposed shift in mortgage regulation on the day the responsible lending proposals were published, where he concluded.
‘This is a major shift in philosophy and I believe a necessary one. But also one which carries risks – the risk that we swing to the other extreme, restricting consumer choice where we do not need to, and imposing regulatory costs which are disproportionate to what we can realistically achieve. We need to strike a balance and, to get that balance right, we need to debate it openly and explicitly with the industry, with the press, with the politicians, with society.'
The CML supports the need for a debate and has contributed to the discussion by undertaking internal research and funding two independent research reports.
- The Impacts on existing consumers
On 5 October, the CML published research looking at the impacts of the proposals on existing customers, concluding that 51% of transactions between 2005 and 2009 would not have been granted on the current terms.
- Consumer impacts
On 4 November, independent consumer research by Policis was published. Using data from a nationally representative sample of consumers, the report looks in detail at current affordability amongst mortgage borrowers, the impacts of the FSA proposals on current borrowing and the impact on future transactions.
The report concludes that only 5% of borrowers are currently struggling to make mortgage payments and that the overwhelming majority of these have either suffered either a reduction in income or unemployment. The majority of borrowers that have suffered similar income shocks are coping, the primary reason being their ability to flex and prioritise their budget to make key payments. An additional report looking at the detailed impacts of low rates on affordability was published by Policis on 15 November.
Looking at the impact of the FSA’s responsible lending proposals, Policis concluded that 19% of current borrowers would fail the new affordability test with an additional 30% being able to afford reduced mortgages.
Of those consumers wishing to move 17% would fail the test with an additional 36% being able to afford reduced mortgages. The impact on prospective first-time buyers who choose to stretch their income is more pronounced with 15% failing the test and an additional 40% being eligible for a reduced mortgage.
- Compliance and costs
The third research report, by Oxera reviews the cost to lenders of the income verification rules in CP 10/16 and how lenders can comply with the new, forward looking, elements of the affordability proposals.
The report concluded that the annual costs of the FSA’s income verification requirements would be between £7.1 million and £10.3 million a year. This is likely to result in some larger lenders not wishing to consider applications from borrowers with complex incomes.
Oxera conclude that the FSA’s requirements to take into account foreseeable changes in income and affordability are impractical in practice and would result in significantly reduced levels of borrowing to compensate events that impact on income and expenditure that may never happen.
The full reports and supporting documents are available on the CML’s research webpage.
Back to top
The CML response to responsible lending proposals (CP 10/16)
The CML has directly contributed to the debate on the future of mortgage regulation and home ownership through a number of speeches by our Director General, Michael Coogan at the CML's Future Housing Conference, on 22 September 2010, and at the launch of the independent research into the impacts of the MMR on 4 November 2010. These speeches outline our policy position as it has developed.
The CML’s formal response to CP 10/16 was published on 15 November and looks in detail at all the proposals and outlines alternative suggestions that seek to enhance protection for customers in proportionate and practical way. Given the weight of evidence around the impacts of the current proposals, the analysis of the detailed rules, the CML believe that the FSA must re-consult on its responsible lending proposals.
Similar concerns have been expressed by a range of stakeholders who have joined the debate including the FSA's consumer panel in its response and in an open letter to the Chancellor of the Exchequer by a number of housing and legal bodies.
At our annual conference on 18 November 2010, our chairman, Matthew Wyles gave a speech outlining this and other key points covered in our response. At the same event Sheila Nicoll, FSA, director conduct risk, outlined that the FSA will be issuing further consultation papers on responsible lending in 2011. The full scope, content and timing of these papers remain unclear.
Back to top
On 16 November, the FSA published the third MMR consultation paper which included policy proposals for distribution and disclosure (CP 10/28). As outlined in our press release in response to the CP, we are concerned that the proposals continue to transfer responsibility (and risk) away from consumers.
In our response (and supporting press release) to the consultation paper, published on 25 February, we highlight a number of concerns with the policy proposals and a lack of consistency between the policy and rules. But welcome the FSA's approach to constructive consultation and dialogue with the industry.
Back to top
The FSA's new approach to conduct risk places a reduced emphasis on disclosure in favour of detailed regulation of the sales process (CP 10/28) and underwriting (CP 10/16) processes as a means of risk management.
This change in emphasis is based on the regulator's view that consumers, in general, do not respond to the risk messages through the disclosure process and would benefit more through more prescriptive regulation of firms.
It is for this reason that the major changes proposed in CP 10/28 focus on the sales process, in particular the development of a single sales standard for both advised and non-advised sales.
In our response to the consultation paper, we looked at the performance of advised and non-advised sales and concluded that the majority of 'higher risk' consumers that would gain the most benefit from advice, had received advice when they bought their mortgage. Only a very small minority of 'high risk' borrowers chose a non-advised, where it may have been more appropriate to receive advice.
From this we draw the conclusion that applying the same standards to non-advised sales - primarily used by lower risk borrowers - would not be an appropriate or proportionate regulatory response, as it does not reflect the differences in consumers' financial capability, particularly as the sales standard proposed by the FSA would create an advised process in all but name.
Back to top
With a changing, and more limited, role for disclosure, the proposals in this section of the consultation paper focus on the 'initial disclosure' messages, regarding the market coverage of a firm and the remuneration arrangements of the seller.
The proposals seek to introduce a specific oral disclosure requirement and will require firms to give consumers the same message at least three times, in at least two different formats, during the mortgage sales process.
We are unsure what benefits consumers will derive from this repetition, particularly as the FSA itself states that initial disclosure messages have little influence on the consumer's decision to chose the mortgage lender or intermediary firm - with other factors (such as personal experience or recommendations from friends or family) being the primary driver. We have encouraged the FSA to undertake some consumer research to determine the consumer benefits of the new approach.
Back to top
Joined-up approach to consultation
In responding to the detail in CP 10/28, and the responsible lending consultation before it, it is apparent that these two major elements of the mortgage market review are ultimately dependent on each other.
To enable a clearer understanding of the impacts of the MMR, for consumers and firms, and how the new distribution, disclosure and responsible lending process will work together, we have called upon the FSA for a single consultation paper that contains all outstanding elements of the MMR - including draft rules and a cost-benefit analysis.
