The Mortgage Credit Directive will be implemented by 21^st March 2016. The Directive aims to create a union-wide mortgage credit market with a high level of consumer protection, and applies to secured credit (first and second charge loans) as well as to home loans.

Product disclosure content and ‘topping up’ the KFI

The KFI is being replaced with a similar document titled the European standardised information sheet or ESIS. Like the KFI it is a prescribed and standardised product disclosure document designed to help consumers shop around. Firms will have until 21 March 2019 to make the transfer to the ESIS, but will need to provide additional information if they continue to use the KFI from March 2016.  For firms who intend to keep using the KFI they will need to make three extra disclosures. These ‘top-up’ disclosures cover:

·      Information on the new seven day right of reflection period the MCD introduces

·      where applicable, extra information for foreign currency loans, including an illustration of the impact of a 20% change in the exchange rate and new rights introduced for foreign currency borrowers because of the MCD

·      information for consumers on the potential impact of interest rate changes, describing both the APRC and monthly payments should interest rates rise to the highest level seen in the past 20 years

Conditional and binding offers

The MCD requires lenders to make a binding offer, whereas in the UK market it is common practice for lenders to first make conditional offers that are then subject to varying degrees of due diligence.  Firms will be able to make a conditional offer and then carry out the further actions they need to satisfy themselves that they are willing to lend on the terms indicated. At a point when they have completed their due diligence, there will have to be a new step. The firm will need to make its offer binding.

Consideration period

The binding offer is also the starting point for a new requirement for consumers to have time to reflect on the offer. This period has to be of at least seven days from the making of the binding offer a compulsory pre-sale seven day period of reflection as this will be much less disruptive for property sales. In line with the directive, the draft rules also set out that the consumer can accept the offer at any point during this reflection period.

Annual percentage rate of charge (APRC)

The existing mortgage rules standardise the way in which firms calculate the annual percentage rate of charge. For loans covered by the MCD, these rules will need to reflect the method now set down in the directive. Although expressed differently from the formula in MCOB 10, the approach to calculating the APRC is very closely aligned with the existing rules.  The MCD introduces a need for a second APRC where borrowing is on a variable rate. This second APRC forms part of the ESIS, and is part of the proposed ‘top-up’ where a firm is still using a KFI.  Where the variable interest rate tracks an external reference rate (such as the Bank of England base rate) the second APRC has to use a 20-year high of that reference rate. Firms will be able to replace the existing risk warning in section 7 of the KFI with the second APRC, in order to reduce the possibility of information overload.

Financial promotions

The MCD also introduces a requirement for firms to provide a full representative example of the mortgage costs if advertising mentions an interest rate or anything to do with the cost of the loan (such as the monthly amount).  

General information

The FCA proposes to copy out MCD requirements for firms to make available general information about mortgages, e.g. how they work and the costs and the choices involved in borrowing.  The information can be on paper, another durable medium, or in electronic form, so firms might choose to provide this information on a website. This will only apply if you are a tied mortgage broker. 

Intermediary service disclosure

The MCD requires intermediaries to provide information on their services in good time before providing the service. Implementation of these requirements will result in some minor changes to the content of the key disclosures. In particular, where an intermediary has ties to either one or a group of lenders they will now need to name these lenders. Firms paid by commission must tell consumers that they have the right to ask for information on the commissions paid by different lenders, and ensure that they have access to relevant market data to allow them to respond to such a request. The MCD will also mean firms having to consider the wider market to which the MCD applies when describing the limitations on their product range.

Many of these new intermediary disclosures must be in writing or made using a durable medium. The FCA do not intend to change the current approach of requiring oral disclosure of the key messages where there is spoken interaction

Tying and bundling

‘Tying’ describes an arrangement where a mortgage is only available if you also take out other financial products or services.  This will be banned as per the MCD, as well as the available exemptions, which allow a firm to:

·      require a tied payment or savings account (either to allow the credit to be repaid or to provide added security for the lender)

·      require an investment or pension product, again either to help in repayment or to provide security. This could be a tied product from the same firm

·      require a mortgage alongside a shared equity loan

·      require an insurance policy e.g. buildings insurance (providing the consumer is free to get equivalent insurance from another firm), or

·      sell a mortgage with another tied product or service where they can show, if challenged, a clear consumer benefit.

Affordability

The MCD requires firms to conduct a creditworthiness assessment for every new loan, to ensure that it is affordable for the consumer.  The existing responsible lending rules for first charge firms already give effect to the MCD requirements; however, firms should be aware that there will be some changes to the rules:

·      A lender will not be able to cancel or alter a credit agreement to the consumer’s harm where they have failed to assess affordability adequately.

·      Lenders will be reminded of their existing obligation under the Data Protection Act5 to tell consumers about any use made of databases. This also covers the details of any database used where the information provided has caused the lender to decline the application.

·      Lenders must set out in advance the information they need to consider any mortgage application. This information must be proportionate to the lender’s assessment.

·      Firms must also inform consumers of their obligation to provide correct information and that not providing this information will stop the lender from considering any application.

Early repayment

Although the ability to repay early is effectively universal in the UK, it has not been a specific right provided by mortgage regulation. The MCD changes this, introducing a right for full or partial early repayment. In other respects the MCD approach is similar to our existing rules, e.g. limiting any charges made by the firm to the costs that are linked to early repayment.

Foreign currency mortgages

The FCA intends to adopt the Directive definition of a foreign currency loan. The definition encompasses loans that are in a currency other than that of the consumer’s income and also loans in a currency that differs from that in the country where the consumer is resident. So, for example, a UK consumer living in Spain but with a sterling mortgage on their UK property would have a loan defined as a foreign currency mortgage.

The new rules include disclosure obligations for firms, both on the potential impact of exchange rate fluctuation, and subsequently if there is adverse exchange rate movement. In addition, lenders must put in place extra steps to protect consumers from exchange rate risks. These might include a right to convert the loan into an alternative currency or to otherwise limit the consumer’s exposure to such risks.

Remuneration

The MCD specifically highlights the need for remuneration arrangements not to cause a conflict with a broad duty on firms to take account of the consumer’s interest when carrying out activities covered by the directive. The MCD also specifies the approach to this kind of conflict management for individuals who are either assessing loans or giving advice.   

Property valuations

Alongside the new conduct obligations introduced by the MCD, there are also some prudential requirements. Firms are required to use reliable property valuation standards and those carrying out property valuations must be professionally competent and sufficiently independent from the mortgage underwriting so they are impartial and objective. For the firms that the FCA prudentially regulate, they will implement these requirements through changes to the MIPRU rules. The PRA will consult separately on introducing these requirements for the firms that they prudentially regulate

Secured Loans

The FCA intend to apply the key protections of the mortgage regime to second charge mortgages, given the potential risks, with the aim of ensuring that consumers enter into second charge mortgages only where:

• it is appropriate for them to do so

• they can afford it

• they are treated fairly if they fall into payment difficulties

Existing second charge loans (the back book)

Second charge loans that are in existence when the FCA implements the new regime will transfer into the new regime. This will mean that the proposed MCOB protections discussed below that apply during the life of the loan, such as post sale disclosure (e.g. annual statements), contract variations, charges, and payment shortfalls and repossessions will apply to existing loans, as well as to new loans made. However, certain existing protections will be retained for existing loans, including the restrictions on early settlement fees.

Disclosure

The MCD will introduce significant changes to disclosure requirements, particularly in relation to pre-sales disclosure.  The existing MCOB requirements around service disclosure will apply to second charge mortgages, so requiring firms to make an initial disclosure covering two key messages about their scope of service and remuneration. The rules will require a third key message to highlight the range of alternative borrowing choices that may be available (e.g. a further advance or an unsecured loan).

Product disclosure

In the second charge market, current product disclosure typically consists of marketing materials and advance copies of contractual information. This will change to comply with the MCD. The new obligation for an ESIS to be provided will fall in line with the requirements on first charge mortgages.

Adequate explanation

A firm needs to provide consumers with an adequate explanation of the product disclosures they have made, the essential features of the product, any ancillary products and the impact on the consumer (including the consequences of default).   This is likely to result in a change in the existing processes of many second charge firms, requiring a new contact point with the customer. The MCD permits different approaches to providing the adequate explanation according to the circumstances of the sale, e.g. whether it is provided verbally or in writing, and whether by the intermediary or the lender.

Offer disclosure

Thepurpose of the ESIS is to help customers shop around, so it must be given out early in the sale. The MCD does not require a further ESIS to be provided to the customer at offer stage unless there has been a material change since the first ESIS was given. However, a firm can choose to give out an ESIS with all offers.   Second charge firms could use their existing arrangements for giving out advance copy documents to satisfy the MCD obligation to provide a draft of the credit agreement.  

Post-sale disclosure

The same approach for post-sale disclosure for second charge mortgages will apply as for first charge mortgages. These requirements apply to disclosure at the start of the contract, annual statements, and to certain event-driven information, such as when a customer experiences payment difficulties or a variation is made to their contract.

At the start of a mortgage contract (i.e. when a mortgage completes, or just as it is about to), it is already common in the second charge market for the lender to contact the consumer to confirm key details, either in writing or by phone. In some cases this might be the first direct contact between the lender and the consumer. The FCA will apply a similar approach in the first charge market, requiring firms to confirm key details when the loan starts. Disclosure at this point has a real benefit in providing a check that the mortgage is set up correctly, preventing initial administrative errors that might otherwise lead to consumer harm and subsequent complaints.  The FCA propose aligning the approach across the first and second charge markets

Similarly, it is reasonable that the same Principles should be seen as ensuring that firms meet the information needs of joint borrowers. The CCA requires information to go to each party individually. Firms generally address communications required under MCOB to all parties jointly (unless, for example, where the firm knows that they live at different addresses), and the FCA plan to apply this approach to second charge loans. Of course, this does not prevent firms (in either the first or second charge market) from individually addressing all communications

Advising and selling standards

Since April 2014 the FCA have required advice to be given in first charge mortgage sales where there is spoken or other interactive dialogue with the consumer. The FCA allow execution-only sales in very limited circumstances, for non-interactive sales (e.g. internet or postal applications), for some contract variations, and for some niche mortgages (e.g. to high net worth customers, mortgage professionals and for business loans).

The same rules willapply to second charge mortgages, to help ensure that consumers buy products that they understand and that are appropriate for their circumstances.

Under the existing rules, where a borrower wants to raise additional funds secured on their property, the FCA require mortgage sellers to inform them that a further advance with their existing lender may be more appropriate than a remortgage. However, there is no obligation for the seller to assess whether the further advance would actually be more appropriate.  In light of the transfer of second charge mortgages to the mortgage regime this will be extended so that in all such sales the customer is made aware that in addition to a further advance or remortgage, a second charge or unsecured loan may be more appropriate. (Once again, the FCA do not require the seller to consider appropriateness of these other options)

Considering the effect of future interest rate rises

TheMCOB affordability rules require lenders to take account of future interest rate rises when assessing affordability (unless the loan is fixed for five years or more, or fixed for the term if less than five years), to do this the lender:

• must consider the expected interest rate environment for a future period of at least five years

• should not use their own forecasts of future interest rates, but instead must have regard to

market expectations, for example through externally published sources such as the Bank of England forward sterling rate; and also to have regard to any prevailing FPC recommendation on appropriate interest-rate stress tests

• should assume a minimum interest rate increase of 1% over the five-year period, even where the market expects interest rates to fall, or rise by less than 1% over that period

This approach will apply to second charge mortgages. In practice, the typically higher interest rate margins involved may mean that product pricing is less affected by interest rate fluctuations than for first charge mortgages (i.e. lenders may have more flexibility when deciding how much of an interest rate rise to pass on to borrowers). The FCA recognise that this may be reflected in the stress rates used by second charge lenders. However, they will expect them to be able to justify the basis they use for interest rate stress tests, and to be able to clearly articulate this and keep appropriate records.

Debt consolidation

For first charge debt consolidation mortgages made to credit impaired consumers the FCA require the first charge lender to either take reasonable steps to ensure the debts to be consolidated are repaid, or include them in the affordability assessment as if they were not repaid.

This will be extended to second charge mortgages. However, given the high proportion of second charge mortgages taken for debt consolidation, and the higher level of payment problems found in second charge debt consolidation mortgages (which are comparable to those historically found in credit impaired first charge mortgages), the FCA will extend the requirement to all second charge debt consolidation mortgages, and not just those made to credit impaired consumers.

Contract variations

To ensure appropriate consumer protection, the current MCOB rules on contract variations will apply to second charge mortgages. These relate to disclosure, advising and selling standards, and responsible lending

Fees

Rolling-up of fees and charges into the loan.  Therules in MCOB 4.6A prohibit fees and charges (such as lender and broker fees) being automatically ‘rolled-up’ into the loan. A fee or charge can only be rolled-up where a customer has made a positive choice that this is what they want. The same rules will apply to the second charge market.

Business loans

In the current consumer credit regime, secured loans that are wholly or predominantly for business purposes, where the loan is over £25,000, are excluded from regulation. Loans up to £25,000 are regulated, on the basis that smaller loans are more likely to be taken by smaller traders who need more consumer protection – for example, to inject cash into struggling small businesses. This approach will be carried across by the government into the mortgage regime, so the FCA will only have the power to regulate secured loans for a business purpose that do not exceed £25,000 (before any fees are added to the loan)

Bridging loans

The MCD has an exemption for bridging loans, and therefore it will not apply to loans that meet its definition of a bridging loan. However, existing MCOB requirements will apply to first charge bridging loans, and given the similar risks to consumers the same will apply to second charge bridging loans. This includes several tailored provisions, particularly in relation to disclosure, advising and selling standards, and responsible lending.

Training and Competency

Staff will have until 21 September 2018 (two and a half years from the date the rules come into force) to obtain the level 3 mortgage qualification. While individuals are in the process of obtaining the qualification, the FCA will expect them to operate under supervision and use the MCD knowledge and competency standards to demonstrate competency on an ongoing basis.

Approved persons

The controlled functions for second charge firms under the consumer credit regime are governing functions, systems and controls functions, and Money Laundering Reporting Officer functions. The controlled functions under the mortgage regime are wider than this, covering all governing functions, Apportionment and Oversight CF8, Money Laundering reporting CF11, and often Systems and Controls CF28 and the Significant Management function CF29.  As second charge mortgages will be covered by the definition of a regulated mortgage contract, these additional controlled functions will apply.

Retail Mediation Activities Return (RMAR)

Applicable to second charge intermediaries, aggregated data covering a firm’s regulated mortgage activity, including second charges.  Changes to forms RMA-B and RMA-G, will take effect from 21 March 2016.   The FCA will require all mortgage intermediaries to submit their indemnity limits for their PII policy in Euros. It is the FCA’s intention to maintain the same reporting frequencies for first and second charge intermediaries.

The FCA have published a paper on the implementation of the Mortgage Credit Directive, CP14/20 here: https://www.fca.org.uk/your-fca/documents/consultation-papers/cp14-20

If you need compliance support to help prepare for the MCD or to evidence compliance checks have been undertaken such as file checking, T&C and TCF please contact us to discuss your requirements and receive a no obligation quote.