21/10/2009

By Neil Ainger

Home owners will have to pass a mortgage affordability test in future from lenders says the Financial Services Authority (FSA) in its Mortgage Market Review discussion paper, which sets out proposals for the future regulation of the sector after the housing crash and banking crisis of the last 18 months. Under the proposals, which are out for discussion until 30 January 2010, self-certification mortgages will also be banned with lenders having to verify borrowers' incomes from now on. No ban is proposed for 100 per cent mortgages though or on certain multiples of borrowers incomes. Similarly, no limit is envisaged on loan-to-value ratios.

The aim of the FSA's Mortgage Market Review proposals is to ensure that the market works better for consumers and is sustainable for all market participants, hopefully avoiding the boom and bust that we have seen in recent years, which has caused pain to ordinary homeowners and the financial sector itself, with Northern Rock and others driven into the hands of the government to prevent a collapse. The UK watchdog admits that this does mean a changed approach towards "a more intrusive and interventionist style of regulation" in future.

The review's key proposals are:
• Imposing affordability tests for all mortgages and making lenders ultimately responsible for assessing a consumer's ability to pay, via scrutinising monthly disposable incomes;
• Banning 'self-cert' mortgages by requiring such verification of borrowers' income;
• Banning the sale of products which contain certain 'toxic combinations' of characteristics that might put borrowers at risk - for instance, giving a high loan to value ratio to someone with a poor credit history;
• Banning arrears charges when a borrower has already arranged a repayment plan and ensuring firms do not profit from people in arrears;
• Requiring all mortgage advisers to be personally accountable to the FSA;
• Calling for the FSA's scope to be extended to cover buy-to-let mortgages and all lending secured on a home [traditionally, buy-to-lets are treated as a business loan and so falls outside the regulator's remit].

In response to the charge that the reforms will penalise self employed people, who have traditionally been heavy users of 'self-cert' mortgages, the FSA says that by looking at the tax returns of such people evidence of their income should be easy to obtain. If getting touch means restricting the easy availability of loans in the past though, then some difficulty in getting on the 'housing ladder' is bound to be encountered.

The FSA has not ruled out further change if its initial proposals do not have sufficient effect, including caps on loan-to-value, loan-to-income or debt-to-income ratios. The regulator is confident though that the irresponsible lending practices seen in the market until recently will be curtailed by the FSA's existing work on capital and liquidity requirements for financial institutions (see its Strengthening Liquidity Standards PS09/16 rules here).

A feedback statement will be published in March next year, illustrating the views of consumer groups and the industry. Implementation of the final proposals will be phased in from 2010 onwards, with the focus initially likely to be on rushing in high impact changes, such as the alterations to how those in arrears are treated.

Commenting on the proposals, Jon Pain, FSA managing director of supervision, said:
"The mortgage market has seen extraordinary upheaval over the last 18 months and whilst it has worked well for the vast majority of borrowers, some have suffered great financial distress. We recognise that we need to bring about a step change in regulation and we need to act now to address the issues we have identified."

Industry reaction
In response, the Building Societies Association (BSA) says that while it believes much of the detail in the paper is sensible, they have significant reservations about the possible unintended consequences of some of the ideas expressed. "We need a sensible balance between appropriate regulation and allowing people to buy their own home when they can afford to do so," says Paul Broadhead, head of mortgage policy at the BSA. "The vast majority of the British population aspire to home ownership and these proposals must not frustrate the sensible ambitions of potential homeowners."

"We are pleased that the FSA is not setting maximum loan to income or loan to value ratios and welcome the need to focus on borrower's levels of disposable income," he added. "But we remain concerned about how the FSA will implement these requirements in practice. It is vital that lenders retain the flexibility to respond to the very individual financial circumstances of individual borrowers."

The BSA went on to say that it doesn't believe a niche product such as 'self-cert' mortgages should ever have reached a market share of anywhere near 45 per cent but that an outright ban is not appropriate as the product is suitable for a minority of people. On the issue of the FSA's commitment to examine the extension of its prudential rules to non deposit taking lenders, the BSA's Broadhead, said: "This would represent a significant levelling of the playing field, and building societies welcome the opportunity to compete fairly with such organisations."

At one point during the housing boom in 2007 more than 10,000 different mortgage products were available, with some 3,000 specifically aimed at sub-prime borrowers.

"This Mortgage Market Review discussion paper sets out the main findings of the FSA's comprehensive analysis of the mortgage market [as was]," explains the FSA's Pain. "It clearly shows a rapid explosion in mortgage products; the emergence of high risk lending strategies which typically focused on higher risk borrowers; relaxed credit standards; and a mutual assumption by too many borrowers and lenders that the good times could not end.

"[In future] the FSA needs to ensure that firms only lend to people who can afford to pay the money back. The reforms that we have announced today will ensure that the mortgage market works better for consumers and that it is sustainable for firms."