The new lending rules - five key changes for borrowers
Published: 4 March 2014 | Author: Bernard Clarke
In less than two months from now – on 26 April – lenders will be required to advance mortgages to their customers under new rules coming into effect as a result of the mortgage market review (MMR). The rules, which are being introduced to reinforce consumer protection, will be overseen by the industry regulator, the Financial Conduct Authority (FCA), and apply across the whole industry.
Lenders have been working for many months to ensure they are ready to comply with the new rules and, in some instances, firms are already applying parts of the new rulebook. But many consumers are still largely unaware of the changes, and what they will mean. Today, therefore, we are looking at some of the ways in which the new rules will affect borrowers – and setting out five key changes that they will see when taking out a mortgage in future.
As far as firms themselves are concerned, a recent survey by the FCA of almost 4,000 lenders and brokers found a high degree of readiness for introducing the new rules. Key findings from the survey included:
- All firms planning to conduct mortgage business say they will implement the MMR on time.
- Less than 1% of firms – all of them thought to be small brokers – say they will not be ready by 26 April. But those firms say they will not undertake any mortgage business until they are fully prepared.
- A large majority of all firms – 85% – have plans for moving to the new rules that are either complete or partially complete.
- Only a tiny proportion of lenders have asked the regulator for any further information. Of 172 lenders responding to the survey, just seven (4%) have done so.
So, what are the key changes that mortgage customers will see as a result of the new mortgage rules?
Taking out a mortgage could take you longer than before.
One of the main effects of the new rules will be to reinforce a clear distinction between mortgages sold on an “advised” or on an “execution-only” basis, with the overwhelming majority of sales being advised. Indeed, some lenders – and most brokers – will only offer advised sales after 26 April.
- The new rules are very prescriptive about giving advice, and the process is likely to take longer than before. Some estimates of the length of the process have been published, but these vary from lender to lender.
- It has been estimated that an advised sale could take up to two hours – perhaps longer – to complete. Even if you are making a change to an existing mortgage, you will be affected by the new rules and may find that the process takes longer than before.
- It is possible, therefore, that some lenders will choose to split the sales process into two separate interview sessions.
Mortgage interviews will be longer because firms will need to ask more questions to determine what mortgage product is suitable for you, taking into account your individual needs and circumstances. Questions that will be covered as part of the advice process include:
- What length of mortgage term is suitable for you?
- Do you need the stability of fixed monthly interest payments, bearing in mind the potential impact on your finances of future changes in variable rates?
- Is a mortgage offering lower monthly repayments at the outset an appropriate option?
- Is it likely that you will make early repayments?
- Should you have a repayment mortgage, an interest-only loan, or a combination of the two?
- Is it appropriate for you to pay any fees or charges upfront, instead of adding them on to the mortgage?
- What other loan features might suit your circumstances?
- Is the mortgage suitable, based on the information you provide and your credit history?
You will need to provide more details about your income and expenditure. Be prepared!
One of the cornerstones of the new rules is that there must be a careful and detailed assessment of the affordability of the mortgage for you. This assessment has to focus not just on the affordability of initial payments, but future ones as well – in an environment in which interest rates may be higher, and allowing for changes in your circumstances that can be reasonably foreseen at the time you take out your mortgage.
The requirement to lend responsibly, and assess affordability, will mean that lenders must take into account your income, committed expenditure and other basic essential expenditure and costs reflecting your quality of living.
You can help yourself through this process by anticipating some of the questions the lender will ask and having to hand appropriate supporting evidence. Documents that may be needed to substantiate income from employment could include:
- payslips, from each job if you have more than one job;
- evidence of any overtime or bonus payments if these are not captured by payslips;
- bank statements, which will help confirm that income is paid regularly; and
- statements from your employer verifying any income that is not contractually guaranteed or which is irregular, including, for example, maternity pay.
If you are self-employed, you may need:
- business plans and future projections of income;
- tax returns, and other details of tax paid;
- business accounts, preferably independently prepared or verified; and
- statements or other verification of income from an accountant or other professional adviser.
Finally, if you want the lender to take into account other forms of income, you may need things like:
- pension statements and projections;
- annuity records; and
- statements of income from investments or rental properties.
You should also expect the lender to ask about questions about any potential changes to your future income and expenditure – for example, forthcoming retirement or anticipated redundancy. As with other requests from the lender for information as part of the application process, it is important for you to answer as fully and openly as possible.
The new rules could affect how much you can borrow.
Lenders will have to ask detailed questions about your spending. They will take into account any expenditure to which you are already committed, and will need to know about credit card and loan repayments, hire purchase agreements and child maintenance or alimony payments. You will be asked to provide evidence to help the lender make a realistic assessment of your commitments.
Firms will also have to allow for spending on essential costs of living, including what you spend on utilities, council tax and telephones, ground rent, building and contents insurance, running a car, and other costs for traveling to work or school, including season tickets. They will also have to make a realistic estimate of other living costs, including clothing, household and personal goods, and recreation and childcare costs.
Another important commitment that lenders will need to take into account for interest-only borrowers is the cost of investments that form part of your strategy for repaying the mortgage at the end of its term.
The rules also require lenders to “stress test” affordability of mortgage payments against higher interest rates. Firms will therefore have to consider likely future interest rate movements over at least five years, based on market expectations (unless borrowers opt to fix their rate for at least this period). Even if rates were expected to fall, lenders would still be required to assess affordability on the basis that there is a rise of at least 1% over the first five years.
You will be able to transact on an "execution-only" basis – but there are strict rules to make sure that you understand the process.
Choosing the execution-only option means you will not receive advice from your lender or broker.
You, as the borrower, are the only one who can instigate an execution-only sale. It will be an option for you, as long as you can show you have researched the market and understand the features of – and commitments associated with – the mortgage you want to take out.
If you want to make this choice, you will have to supply information about the mortgage you want including details of the contract you wish to purchase; the name of the lender; the interest rate you will pay; whether it is fixed, capped, variable or a tracker, and any other features of the rate; the value of the property securing the loan; the length of the mortgage term, the amount you are seeking as an advance; and the method of repayment.
As part of the process, the lender will make a declaration that advice has not been provided to you. This declaration will say that the firm is not required to assess whether you have chosen a contract that is suited to your needs, and will inform you that, if you proceed, you will not be protected by the rules covering the provision of advice. In most cases, you will then have to confirm in writing that you are happy to proceed on that basis.
In most execution-only transactions, there can be no discussion between you and the lender. Most sales of this type are likely to be online.
Some lenders, and most brokers, will only offer advised sales.
It will still be possible for you take out an interest-only mortgage – but this will remain a niche offering.
The number of new interest-only mortgages has already contracted sharply, and some lenders have already decided to withdraw completely from this section of the market.
Lenders continuing to offer interest-only mortgages will need to ensure that you have a credible strategy for repaying the loan when it matures. They may accept a range of different strategies from you for this, and they will ask for evidence to support your chosen strategy. Examples could include:
- Regular deposits into a savings plan, or an investment product like an ISA. However, there may be requirements to provide supporting statements and projections of returns.
- The use of bonus payments or other irregular sources of income, again supported by evidence that could include payslips or statements from an employer.
- The sale of assets, supported by a valuation or other proof of value and ownership.
The overwhelming majority of lenders are on course to implement the new rules for mortgage lending at the end of April, as anticipated. Some have already begun to switch their systems over and are already applying some of the new rules in practice.
Customers are therefore already beginning to see changes in the process of taking out – or even amending – a mortgage, and will definitely do so after 26 April. The changes are being introduced to reinforce consumer protection.
Borrowers will see benefits from greater consistency in the approach to assessing whether the mortgage is affordable, and appropriate to individual needs and circumstances. But, as this article highlights, they will also see a process that is more intrusive and onerous than they may have experienced in the past.