««« Consultation Paper Consultation 10/16 Financial Services Authority Mortgage Market Review: Responsible Lending July 2010 Contents List of acronyms used in this paper 3 1 Background and overview 5 2 Affordability assessments 12 3 Product regulation 41 4 Arrears charges 45 5 Responsible borrowing, better informed purchasing 57 6 Non-deposit taking lenders 62 Annex 1: Part 1 Detailed cost-benefit analysis for proposals on responsible lending and arrears charges Annex 1: Part 2 High-level cost-benefit analysis on current position on interest-only mortgages and non-banks Annex 1: Part 3 Compatibility statement Annex 2: Arrears charges analysis Annex 3: Responsible lending data pack Annex 4: List of consultation questions Appendix 1: Part 1 Affordable borrowing and home financing draft instrument Appendix 1: Part 2 Payment shortfall charges draft instrument © The Financial Services Authority 2010 The Financial Services Authority invites comments on this Consultation Paper. Please send your comments to us by the following dates: • on questions 16 to 22 about interest-only mortgages and questions 33 and 34 about non-deposit taking lenders, by 30 September 2010; and • on all other questions, by 16 November 2010. Comments may be sent by electronic submission using the form on the FSA’s website at (www.fsa.gov.uk/Pages/Library/Policy/CP/2010/cp10_16_response.shtml). Alternatively, please send comments in writing to: Lynda Blackwell Conduct Policy Division Financial Services Authority 25 The North Colonnade Canary Wharf London E14 5HS Telephone: 020 7066 0168 Fax: 020 7066 0169 E-mail: [email protected] It is the FSA’s policy to make all responses to formal consultation available for public inspection unless the respondent requests otherwise. A standard confidentiality statement in an e-mail message will not be regarded as a request for non-disclosure. A confidential response may be requested from us under the Freedom of Information Act 2000. We may consult you if we receive such a request. Any decision we make not to disclose the response is reviewable by the Information Commissioner and the Information Tribunal. Copies of this Consultation Paper are available to download from our website – www.fsa.gov.uk. Alternatively, paper copies can be obtained by calling the FSA order line: 0845 608 2372. List of acronyms used in this paper BCBS Basel Committee on Banking Supervision BoE Bank of England BIPRU Prudential sourcebook for Banks, Building Societies and Investment Firms CBA Cost Benefit Analysis CFEB Consumer Financial Education Body CML Council of Mortgage Lenders CP Consultation Paper CRD Capital Requirements Directive DCLG Department of Communities and Local Government DP Discussion Paper DSR Debt Service Ratio DTI Debt-to-Income (ratio or multiple) ECB European Central Bank EFS Expenditure & Food Survey ERC Early Repayment Charge FSMA Financial Services and Markets Act 2000 GDP Gross Domestic Product GENPRU General Prudential sourcebook HMRC Her Majesty’s Revenue and Customs IMLA Intermediary Mortgage Lenders Association Financial Services Authority 3 LCS Living Costs & Food Survey LTI Loan-to-Income (ratio) LTV Loan-to-Value (ratio) MCOB Mortgages and Home Finance: Conduct of Business sourcebook MFI Monetary Financial Institutions MIPRU Prudential sourcebook for Mortgage and Home Finance Firms and Insurance Intermediaries MLAR Mortgage Lending and Administration Return MPPI Mortgage Payment Protection Insurance NIV Non-Income Verified OFT Office of Fair Trading ONS Office of National Statistics PSD Product Sales Data SEH Survey of English Housing SPV Special Purpose Vehicle SVR Standard Variable Rate TCF Treating Customers Fairly TPA Third-party Administrator 4 CP10/16: Mortgage Market Review: Responsible lending (July 2010) Background 1 and overview Introduction 1.1 Our review of the mortgage market began in 2005 when we launched the first of two studies of the effectiveness of the mortgage conduct regime introduced in October 2004.1 Those customer-facing reviews were complemented by a series of firm-facing thematic projects which also began in 2005. Those early reviews looked at responsible lending practices in the areas of sub-prime, interest-only, self-certified mortgages and lending into retirement.2 At that early stage we were finding weaknesses in responsible lending practices and in firms’ assessments of a consumer’s ability to afford a mortgage, and had already started working with the industry to try and raise standards. 1.2 Events in the financial market from late 2007 onwards inevitably affected our work and brought a much wider remit, extending it beyond a narrow conduct focus to the wider prudential and macroeconomic context. As we have said previously, the mortgage market worked well for many consumers. But it was also clear that the existing regulatory framework had been ineffective in constraining particularly risky lending and unaffordable borrowing. Circumstances led lenders to feel insulated from losses arising from poor lending, largely as a result of being able to pass risks onto others (e.g. by securitisation) and also by the widely held expectations of continuing growth in property values. This resulted in relaxed lending criteria and increased risk taking, and increased competition pushed lending further along the risk curve with a rash of new market entrants (often non-deposit taking lenders) adding to this. 1 Mortgage Effectiveness Review – Stage 1 report (September 2006) http://www.fsa.gov.uk/pubs/other/mortgage_ review.pdf and Mortgage Effectiveness Review – Stage 2 report (March 2008) http://www.fsa.gov.uk/pubs/other/ MER2_report.pdf. 2 The findings of these thematic reviews were widely communicated, for example, in press releases http://www. fsa.gov.uk/pages/Library/Communication/PR/2007/081.shtml, speeches http://www.fsa.gov.uk/pages/Library/ Communication/PR/2007/120.shtml and enforcement cases http://www.fsa.gov.uk/pages/Library/Communication/ PR/2007/094.shtml. Financial Services Authority 5 1.3 The continued boom in house prices and this ready availability of credit allowed many households to take on even more debt. This increase in mortgage borrowing included extended access to higher-risk groups, such as the credit impaired, who had previously been excluded. So far in this downturn we are seeing problems concentrated among such borrowers and characterised by apparently higher-risk lending practices. 1.4 With the Bank of England (BoE) Bank Rate at a historically low level the majority of borrowers currently enjoy lower mortgage rates. Together with the various government initiatives and improved lender forbearance, this disguises the full impact of unaffordable lending and the true extent of the vulnerability of many consumers to upward interest rate movement, as we discuss in Chapter 2. 1.5 Our approach to retail conduct of business regulation and supervision generally has undergone fundamental change. We will no longer intervene based solely on observable facts and we will no longer wait for our effectiveness and thematic reviews to highlight crystallised risks before acting. We are prepared to take a much more robust and interventionist approach to regulating firms and markets, intervening early where necessary to shape the market to deliver appropriate outcomes and address problems before they cause substantial consumer detriment. 1.6 In line with this new approach, this Consultation Paper (CP) sets out the changes we believe are needed to deliver a more responsible approach to lending in future, to ensure a sustainable market and one that works better for consumers. We believe that a robust and effective assessment of individual affordability has to underpin any sustainable lending model. This will address one potential cause of business failure as well as contributing to the fight against financial crime. By the same token, ensuring that individual borrowing decisions are responsible and affordable will also limit harm. 1.7 This CP also presages a more interventionist and robust approach to challenging unfair charging practices in the market. We indicated in the Mortgage Market Review (MMR) Discussion Paper (DP09/3) that we had work underway to help us develop a better understanding of charging and pricing structures in the market. This should enable us to identify and challenge unfair and excessive practices. The first stage of that work looked at arrears charges and this CP presents the outcomes of that review. It sets out proposed changes to our arrears-charging rules to clarify the approach we expect firms to be taking under our existing requirements. 1.8 There are two areas that we open up for further debate in this CP. One is our approach to regulating non-banks. The other is our approach to interest-only mortgages. We invite further debate and discussion on both topics to help inform our final proposals, which will be consulted on at a later stage. 1.9 The overall aims of the MMR are to have a mortgage market that is sustainable for all participants and to have a flexible market that works better for consumers. We believe that the proposals set out in this CP will go a long way to help deliver these aims. 6 CP10/16: Mortgage Market Review: Responsible lending (July 2010) European dependency 1.10 There continues to be considerable interest at a European level in the case for policy interventions in the retail mortgage market. A possible strategic initiative on responsible lending and borrowing was referred to in the European Commission’s published work programme for 20103 and further discussions are planned. 1.11 We have closely engaged with the Commission and a number of key European stakeholders over the course of our review, to ensure a good understanding of our analysis and the national market issues that we are addressing. We will, of course, continue these discussions, drawing on the substantial evidence base we have for the UK market and our policy in light of this. 1.12 The uncertainty about the timing and form of any European policy intervention is not a reason for delaying policy proposals we consider necessary to address UK market detriment.