On 27 March 2015 the FCA published final rules in relation to the implementation of the Mortgage Credit Directive into UK law. The Mortgage Credit Directive must be implemented by member states, no later than 21 March 2016 and save for a number of transitional provisions, the new rules will take effect from this date. It is, however, possible to comply with the final rules from September 2015.
The aim of the FCA and HM Treasury is to implement the Mortgage Credit Directive by using and supplementing existing FCA rules that apply to first charge lending to retail clients and which are set out in the FCA’s Mortgage Conduct of Business Sourcebook (“MCOB”).
Wider definition of a Regulated Mortgage Contract
Buy to let lending
The current definition of a UK regulated mortgage contract is (in summary) a loan to an individual which is secured by a first charge over residential property lived in by the borrower or members of the borrower’s family. This definition therefore excludes most buy-to-let lending. In contrast the Mortgage Credit Directive encompasses all mortgage lending to consumers, including buy-to-let lending. The Directive provides members states with the option of introducing a lighter touch regulatory regime for buy-to-let lending and the UK government will take advantage of this option.
It is important to be aware that the Mortgage Credit Directive only regulates lending to consumers and therefore if the borrower is entering into a buy-to-let mortgage for business purposes, then the new rules will not apply.
The HM Treasury consultation papers state that examples of the buy-to-let lending where the borrowers are not acting in a business capacity would include situations where the property has been inherited or where a borrower has previously lived in a property but is unable to sell it so resorts to a buy-to-let arrangement.
The FCA proposals for the light touch regime include:
Second Charge Lending
The Mortgage Credit Directive applies not only to first charge mortgages but also to second and subsequent charge mortgages and so the regulation of second charge lending in the UK will move from the consumer credit regime to the MCOB regime. A consequence of this change is that the existing exemptions often used by lenders when making second charge loans (such as an exemption for loans to high net worth borrowers or loans made by UK deposit takers secured over land) will no longer apply to such loans.
Documentation and Presale Disclosure Requirements
The European Standardised Information Sheet (“ESIS”)
The Key Facts Illustration (“KFI”) provided for under MCOB will be replaced by the European Standardised Information Sheet. Much of the required information in the ESIS is similar to that in the existing KFI, however, additional information will be required including information on the new seven day right of reflection period (see below), as well as information regarding the potential impact of interest rate changes. The ESIS will set out both the APRC (see below) and example monthly payments should interest rates rise to the highest level seen in the past 20 years. UK firms have until 21 March 2019 to provide an ESIS but must include top-up disclosures in KFIs by 21 March 2016.
The Annual Percentage Rate of Charge (“APRC”)
The Mortgage Credit Directive sets out a formula for calculating the APRC. This formula is slightly different to the current formula for calculating the APR in MCOB. The FCA propose to retain the old MCOB calculation for loans which fall outside the scope of the Mortgage Credit Directive.
The Mortgage Credit Directive introduces the need for a second APRC where borrowing is on a variable rate. The calculation of this APRC must use a 20 year high of the external reference rate tracked by the mortgage (or where relevant a benchmark set by the FCA).
Binding Offers
The Mortgage Credit Directive requires lenders to make a binding offer in relation to a mortgage. This is in contrast to UK market practice where lenders typically make conditional offers. The final rules allow firms to carry on making draft nonbinding offers provided a binding offer is issued at a later stage.
Pre-sale Reflection Period
The Mortgage Credit Directive imposes a requirement for borrowers to be given a seven day period to reflect on their mortgage offer. The FCA proposes to require lenders to offer a pre-sale period of reflection (rather than a post-sale coolingoff period) which has the advantage that the consumer can accept the offer at any point during the reflection period.
Conduct and Procedural Requirements
Knowledge and Competency
The Mortgage Credit Directive sets minimum standards of professionalism not just for the sales teams and mortgage advisors, but also for people involved in the manufacture and granting of mortgages. The existing level 3 examination requirement will remain for mortgage advisors but the FCA’s training and competence (TC) rules will be amended to include members of staff involved in the manufacture of mortgages or the granting of credit, including board members and legal and compliance teams. These individuals will not be required to pass a specific examination, however, they must meet appropriate knowledge and competency requirements including, where applicable, appropriate knowledge of credit products, credit laws and regulation, the mortgage market and business ethics.
Tying and bundling
The Mortgage Credit Directive prohibits arrangements where a mortgage is only available if the borrower also takes out other financial products or services. The FCA’s proposed rules do permit lenders to require a tied payment or savings account or an investment product to allow credit to be repaid or to provide additional security for the lender.
Lenders are also permitted to require borrowers to have suitable insurance policies in place, such as buildings insurance.
Property Valuations
Lenders will be required to use reliable property valuation standards when deciding whether or not to grant regulated mortgages and those carrying out property valuations must be professionally competent and sufficiently independent from the mortgage underwriting so that they are impartial and objective. Lenders will still be able to carry out their own valuations in-house, however, they must meet a recognised standard such as that set by RICS or the International Valuation Standards Committee.
Alternative Finance Options
The FCA is proposing to impose a requirement that when a customer is considering raising additional monies through a remortgage or a second charge loan the lender must inform the borrower that it may be possible, or more appropriate for the borrower to use an alternative finance option (such as an unsecured loan, a second charge or a further advance).
Foreign Currency Mortgages
A foreign currency mortgage is defined in the draft rules as a loan that is in a currency other than that of the customer’s income or in a currency that differs from the currency in the country where the customer is resident. This will cover more loans than the current MCOB rules regarding foreign currency mortgages. Lenders are required to provide an appropriate disclosure about the exchange rate fluctuation for foreign currency mortgages and must put in place extra steps to protect customers from the exchange rate risks (such as the right to convert the loan into an alternative currency).
Conclusions
Firms need to consider revisions to existing lending documentation and procedures. The extension of the mortgage regime to second charge lending and to buy to let lending will need careful scoping by lenders.
