Lenders need 18 months for implementation - but remain open for business
Published: 30 October 2012 | Author: Bernard Clarke
After more than three years of debate and deliberation, lenders now have the final mortgage rules. There are still many challenges ahead, and firms are grateful they will have 18 months for implementation.
It will be an enormously busy period, as firms change their systems in anticipation of the outcome of the Financial Services Authority’s (FSA) extensive mortgage market review. But as lenders work their way towards full implementation of the rules, they remain open for business to both new and existing customers.
The long period of extensive and detailed consultation over the rules has meant that there are few shocks or surprises in what the FSA published last week. Affordability for the borrower; verification by the lender; and responsible lending are the key principles underpinning the rules.
We are pleased that the FSA has listened carefully to the industry, and has moderated some earlier proposals that would have been difficult to implement, or unduly restrictive.
A "common sense" approach to lending
A consistent theme flowing through the rules, and highlighted by the FSA, is the desire to reinforce a common sense approach to lending. Most of the market has already anticipated the regulator’s broad approach, which puts the customer at the heart of the process and seeks to ensure that he or she is adequately protected.
Last week’s publication by the FSA of Mortgage Market Review - feedback on consultation paper 11/31 and final rules is not the first time the regulator has been spelled out this broad approach. Its earlier guidance consultation document Risks to customers from financial incentives, published in September, heralded a move away from incentivised sales to an approach putting the customer’s interests at the heart of the process. The basic message from both documents is that the regulator wants to address any potential causes of consumer detriment.
Higher costs of regulation
While there were few surprises in the final rules, one unexpected and unwelcome outcome is an increase in implementation and compliance costs for the industry.
The FSA’s reasoning for this was that it had previously under-estimated the impact of removing non-advised sales. It has now revised its estimate of the cost to take into account the fact that some lenders currently have a large percentage of non-advised sales, and may need to recruit additional staff. As a result, estimates of both one-off and continuing compliance costs have increased by £2 million.
This may seem like a relatively small adjustment but it reminds us that striking the right balance between the costs and benefits of regulatory change remains crucial.
The FSA has already said that the operational costs of the new Financial Conduct Authority (FCA) will be greater as a result of its more intrusive approach and enhanced supervisory powers. There are also many indirect costs for firms in the process of regulatory reform that are not immediately obvious and remain difficult to define and quantify.
The regulatory burden will be costly and time-consuming, and the challenges will be greater still for smaller lenders.
As expected, the FSA has left broadly unchanged its proposals for interest-only mortgages.
Borrowers seeking this option will now need to have a clearly understood and credible strategy for repaying the capital at term. Importantly, however, the onus and responsibility for repaying the capital will remain with the borrower.
We had warned that requiring lenders to assess the credibility of individual repayment plans could be interpreted by borrowers as an endorsement that their proposed strategy would achieve the desired outcome.
By making it clear that the lender is not responsible for the performance of the repayment strategy, the FSA has eliminated any chance that borrowers will misinterpret any assessment of their repayment plan as an active endorsement.
The FSA has also recognised that not all borrowers are the same. Depending on individual circumstances, they may have different strategies for repaying the loan, and the regulator will not be overly prescriptive about the approach taken. So, while speculation about house price rises has been ruled out as a credible strategy, lenders will have a degree of flexibility in how they assess borrowers’ plans for repaying the loan.
What will all this mean in practice? In increasing the regulatory burden, the FSA is cementing in place the certainty that interest-only mortgages will be a niche product in future. We believe that there is still a market for this option because it meets the needs of borrowers in a number of different circumstances. But we agree with the FSA that interest-only should not be chosen purely on the basis of cost by a borrower who eventually wants to own their home outright but has no credible plan for repaying the capital.
Lending into retirement
Despite discussion in the consultation phase of a mandatory age limit for customers borrowing into retirement, the FSA has confirmed that the new rules will not adopt this approach. The regulator is proposing that lenders can base their assessment on the customer’s expected retirement age, rather than state pension age. But lenders will be expected to assess income into retirement in deciding whether the loan is affordable.
Existing borrowers will also be subject to an assessment of affordability should they wish to extend their loan beyond their expected retirement age.
What happens now?
Firms will need the 18-month timeframe for implementation before the rules come into effect in April 2014. Next year, the FSA will be replaced by the FCA. We hope that, from a supervisory perspective, the regulator will focus on helping lenders meet the regulatory requirements, as well as on enforcement action if rules are broken.
Generally, we support the FSA’s proposals – but there should be a clear understanding by all that the regulator has permanently embedded a more conservative market.