Regulatory update: TR16 / 4 - embedding the mortgage market review: responsible lending review

Posted: 31st May 2016

“Firms have recognised and positively engaged with the aim of our responsible lending rules. There was no evidence of previous poor practises like self-certification of income or interest-only lending without a credible repayment strategy. Where lending is affordable, we did not see evidence that responsible lending rules have prevented creditworthy consumers obtaining loans.”
(FCA, TR16 / 4)

Background

The Mortgage Market Review (MMR) was introduced in April 2014 and was arguably the biggest overhaul of regulation in the UK mortgage market in over a decade. It gave specific rules and guidance for lenders and laid responsibility for affordability firmly at their doors. It required lenders to:

• Assess affordability on the basis of a borrower’s verified income, credit commitments, essential expenditure and basic quality of living costs
• Take into account known or likely future changes to income and expenditure
• Consider the effect of expected future interest rate rises
• Not assess affordability on the basis of self-certified income or house price inflation
• Only grant an interest-only mortgage where the customer has a credible repayment strategy.

The FCA has now published its thematic review on responsible lending in the mortgage sector, which was to review how the new rules have been implemented and how they are affecting the consumer. This was published alongside the FCA’s feedback statement FS16 / 3 - Call for Inputs on competition in the mortgage sector.

The thematic review confirms the impact of MMR has had no material impact on lending volumes, although with a subdued market there may be a greater impact when interest rates rise and affordability is stretched. It has also identified areas where lenders could make further improvements to their affordability models and, particularly, in evidencing how they arrive at their lending decisions. More widely, the FCA has urged firms to continue developing a range of products that can meet the needs of older consumers who represent an increasing proportion of the British population.

Key points and concerns from TR16/4

Customer demographic and record keeping

Based on the findings, the regulator has said that there was no evidence that the rules of MMR prevented lending to particular groups except for lifetime mortgages, in this market the FCA have said firms can approach them for modification of the rules and they will take a view to updating the handbook as they have concerns that the rules may have restricted the development of these types of products.

The regulator recognises the need for lending to older borrowers in general and still wants firms to focus on product development in this area. This will be included in the wider strategy work from the FCA.

Self-employed customers and customers in more complex scenarios presented affordability challenges, indicating that staff weren’t always able to assess customer information against policy accurately, or that policy was not detailed enough. There was an overreliance in larger lenders on automated decision processes which meant that the lenders were unable to demonstrate how the overall lending decision was made in line with the record keeping requirements required by SYSC 9 (Record Keeping) and MCOB 11 (Responsible lending, and responsible financing of home purchase plans).

Affordability models

The amounts lenders are prepared to approve was found to vary depending on the lender. The regulator specifically references the online affordability calculators available to customers in this regard. It expects firms to communicate in a clear, fair and non-misleading way and highlights how some firms’ calculators provided relatively accurate results in line with lending decisions with signposted help text, which the FCA cited as helpful to those with more complex incomes. Conversely, other calculators were found to be based on simple income multiples, which meant that they could provide inaccurate estimates for certain types of borrower.

Automated Income Verification was also considered in the thematic, and the regulator commented that this is probably only suitable for more simple forms of income, such as basic pay only, as it looks at income going into a current account rather than actual pay. The risk here is that affordability decisions could be made on lower income figures than the consumer is actually paid, and therefore lending decisions could be made based on an inaccurate view of the customer’s true ability to afford repayments.

With regards to incomings and outgoings, some lenders were looking at statistics, either from their own data or from the Office of National Statistics (ONS), and challenging customers where their forecast looked unrealistically low. One firm was actually cross checking ONS data with income and expenditure details collected through interactions with arrears and interest-only maturity customers.

Regulatory next steps

The FCA will continue to engage with firms and have encouraged lenders to consider their processes and the areas of concern highlighted above. They also intend to undertake a targeted market study focused on consumers’ ability to make effective choices, which was discussed in the FS16/3.

Key Questions for Firms

Given the contents of the thematic review, firms can consider the following when assessing their own activity in this area:

• How do you ensure that underwriters are able to accurately assess more complex incomes?
• How do you ensure that expenditure modelling currently uses, and continues to use, realistic assumptions to determine the expenditure costs of borrowers?
• How have you justified the interest rate stress test used in lending decisions?
• Where relying on automated systems and processes, what controls, testing and periodic MI reviews do you have in place to ensure you are delivering the requirements of MCOB 11 and good outcomes for customers?
• Does your record-keeping allow you to demonstrate how you have complied with rules and how the lending decision was reached?
• How does your QA process ensure that the end to end affordability assessment is providing the right outcome for customers?

Huntswood will continue to stay abreast of issues in this space and keep you updated on the things to consider within your firm.