Financial Conduct Authority – Written evidence (EHM0150)
Response to the House of Lords Economic Affairs Committee Inquiry into the Economics of the UK Housing Market December 2015
1. Introduction
1.1 The FCA welcomes the opportunity to provide written evidence to the Committee’s inquiry into the UK’s housing market.
1.2 We are an independent regulator with responsibility for the conduct regulation of over 73,000 firms, and we are also the prudential regulator for those firms not regulated by the Prudential Regulation Authority. We have a strategic objective to make sure that the relevant markets function well, and our statutory operational objectives are the protection of consumers, to protect and enhance the integrity of the UK’s financial system, and the promotion of effective competition.
1.3 We regulate firms and approve individuals that are involved in advising on, arranging or managing home finance, including mortgages. This written submission focuses on the impact of the Mortgage Market Review as the part of the call for evidence most relevant to our remit.
2. Executive Summary
2.1 The Mortgage Market Review (MMR) was a comprehensive review undertaken by the FSA/FCA. Finishing in 2012, it looked at the conduct and prudential standards that applied to mortgage lenders. Its final rules came into effect in April 2014.
2.2 The MMR was designed to prevent a return to the poor lending practices of the past, which contributed to the financial crisis, while allowing customers who can afford to take out a mortgage to do so. It did so largely through changes to affordability requirements. These changes, and the way that they were implemented by firms, received much scrutiny.
2.3 It is important to note that lenders’ risk appetites had changed post-crisis, before our MMR rules came into effect. The MMR changes are intended to hard wire the greater responsibility that the market has shown post crisis. The effect of this will be less visible while the market is subdued, as is now the case, and our evidence suggests that there have not been any substantial shifts in the level of lending to any consumer group since our changes took effect. However, we estimate that MMR will have a bigger impact as the market picks up.
2.4 We are looking at the impacts of the MMR, including through our responsible lending review and a call for inputs on competition in the mortgage sector.
3. Background information
3.1 Between 2009 and 2012, the FSA, our predecessor body, undertook a substantial review of conduct and prudential standards that applied to mortgage lenders, intermediaries and administrators – the MMR. The MMR was a sector-wide intervention aimed at resolving market and regulatory deficiencies in the first charge residential mortgage market. While the mortgage market worked well for the majority of consumers, there were a significant number for whom irresponsible lending practices had led to unsustainable levels of borrowing. The MMR is intended to prevent this reoccurring.
3.2 Final rules were published in Policy Statement PS12/16 (October 2012) and came into effect on 26 April 2014. Among the changes were tighter requirements to assess affordability so as to prevent a return to poor lending practices seen pre- crisis, while ensuring continued access for borrowers who could demonstrably afford a mortgage. The key changes to affordability assessments include the following:
- Placing an obligation on lenders to assess affordability on the basis of borrowers’ income, credit commitments and essential expenditure (e.g. utilities and essential travel costs). These affordability assessments were required both for mortgages provided directly and through intermediaries. Prior to this, a lender could rely on less stringent affordability checks undertaken by the intermediary;
- A ban on self-certified mortgages, requiring instead that income is verified in all cases;
- Stress testing against future interest rate rises. (In May 2014, this was supplemented by an additional requirement to ‘have regard to’ any prevailing Financial Policy Committee (FPC) recommendation on appropriate interest- rate stress tests – currently a 3% increase over five years); and
- Only allowing a borrower to take out an interest-only mortgage where there is a credible repayment strategy in place.
3.3 In the weeks following implementation of these new rules, there was some criticism and reports of a negative impact on the market, including reports of customers experiencing delays booking an appointment with a branch advisor, as well as lengthier interviews with more intrusive questioning on income and expenditure. However, as this submission will show, our data does not currently point to any substantial shifts in lending to particular groups.
4. Thematic Reviews to test implementation of the MMR and the impact on consumers
4.1 In our 2014/15 Business Plan we committed to undertaking two thematic reviews to understand how firms have implemented the new rules and to assess the outcomes for consumers. In July 2015 we published the findings of the first of these, our review into how firms provide mortgage advice after the MMR, which required advice to be given for the great majority of sales. Although our review found that only a small minority of sales (3%) resulted in an unsuitable recommendation, one of our findings was that firms need to strike a more appropriate balance between relying on structured questions and taking account of individual customers’ needs and circumstances. We also saw that some firms had identified issues with their advice processes and were making changes to improve their service to customers.
4.2 Our responsible lending review, which is underway now, is assessing how firms have implemented and are applying the new affordability standards. We expect to publish the findings next year.
4.3 Also flagged in the Business Plan was our call for inputs on competition in the mortgage sector, published in October 2015. This asked for views on whether aspects of the regulatory regime are acting as barriers to firms that wish to enter, compete or innovate in this market. We aim to publish a feedback statement in the first quarter of 2016.
5. The changed mortgage landscape
5.1 The mortgage market originally existed to help consumers to buy their own homes. While regular surveys still cite around 80% of the population aspiring to home ownership, the stock of homeowners with a mortgage has fallen by 1.4 million since 2000 (Annex A – Chart 1).
5.2 The decline started in the 1980s, although home ownership levels were temporarily supported by the Right to Buy scheme. The decline became more noticeable in 2000 as house prices rose relative to first time buyer (FTB) earnings (Chart 2). Despite falling levels of home ownership and falling FTB numbers, the level of secured debt doubled in pre-crisis years driven by rising house price rises. However, the increased levels of secured debt did not reflect increased levels of home ownership, but rather a dramatic increase in remortgage activity fuelled to a considerable extent by mortgages being renewed every 2 to 3 years, often to withdraw the value of equity growth (Chart 3). Remortgage finance was also extended to consumers in financial difficulties who could self-certify their incomes, withdraw equity and opt for an interest only mortgage to aid affordability.
5.3 The landscape today looks very different. The financial crisis, the closure of the wholesale funding markets for non-bank lenders and reduced risk appetites have shifted lending back towards lower risk, lower loan-to-value (LTV) business. Falling levels of equity growth, the withdrawal of self-certified mortgages and limited availability of interest-only mortgages has resulted in a substantial fall in remortgage lending. The availability of low Standard Variable Rate (SVR) mortgages has continued to reduce the incentive for many borrowers to remortgage, although this is slowly starting to change as more borrowers look to fix their interest rates because of potential future interest rate rises.
5.4 One key point to note is that lenders’ risk appetites changed in advance of the MMR rules being implemented on 26 April 2014, as shown in the following table. The change in credit conditions can also be seen in the application and approvals data (Chart 4); in the years prior to the crisis the gap was negligible. Before the MMR rules came into effect, 43% of all applications were approved and by the end of 2014 the figure reduced only marginally, to 41%. While this can be as a result of property transactions falling through this also indicates that risk appetites started to change before the MMR rules came into effect.
Impact of the MMR on different types of customers
| 2007 | 2009 | 2011 | 2013 | 2014 | 2015 (Q1-Q3) |
Value of regulated mortgage sales |
£294bn |
£124bn |
£124bn |
£143bn |
£163bn |
£126bn |
Number of mortgage sales (excl. further advances and equity release) |
2,136,453 |
944,965 |
890,242 |
936,956 |
992,978 |
732,011 |
Percentage of new lending by borrower type | ||||||
House purchase | 47% | 54% | 56% | 64% | 68% | 64% |
FTB | 16% | 20% | 21% | 27% | 30% | 29% |
Remortgage | 49% | 43% | 41% | 34% | 30% | 33% |
Non-verified incomes | 49% | 43% | 30% | 17% | 10% | 0% |
Interest only | 32% | 23% | 15% | 6.3% | 5.2% | 3.9% |
Credit impaired | 3.70% | 0.46% | 0.35% | 0.20% | 0.30% | 0.50% |
Self employed | 17% | 12% | 10% | 10% | 10% | 10% |
5.5 The cost benefit analysis (CBA) we developed to support our consultation on the MMR draft rules considered the impact of the MMR responsible lending rules under two scenarios – subdued market conditions and conditions seen in a boom period. In subdued market conditions, we estimated that around 2.5% of borrowers would either be excluded from the market or would be able to borrow less because in these conditions, lending standards would already have tightened. However, in a boom period, the MMR responsible lending rules were likely to act as a significant constraint by preventing the return to the lending standards seen in the 2005-2007 period. We estimated that around 11.3% of borrowers would be impacted in this scenario.
5.6 Regardless of the market conditions, we expected that certain groups of consumers would be more impacted by the new responsible lending rules than others, such as those seeking interest-only mortgages, the self-employed, and those with a poor credit record. However, our data shows a downward trend in lending to all of these types of consumers since 2008, in advance of the rule changes in April 2014.
5.7 Interest-only (Chart 5 – Repayment Methods) – the interest only market has dramatically reduced from 32% in 2007 to less than 5% of new mortgage sales today. Our rules do not ban interest-only or set maximum LTV limits or minimum loan sizes – any actions lenders have taken in these areas are primarily driven by their own credit risk appetites. We have made it clear that interest-only mortgages can be an appropriate option for some consumers; however, firms must not lend on an interest-only basis unless the customer has a credible plan in place to repay the capital.
5.8 Self-employed (Chart 6 – Employment Status) - a feature of the mortgage market in the run up to the crisis was the extension of credit to borrowers who were previously poorly served by lenders – borrowers such as the self-employed who were not able to provide proof of income. Their choice had been restricted to a specialist lending sector but these consumers became a target for some of the mainstream lenders in the pursuit of lending growth. The ensuing competition meant that many firms under-priced the extra risks being taken on board.
5.9 Self-employed customers who can provide evidence of earnings should not be disadvantaged by the new affordability rules. The MMR does no more than require the lender to assess affordability for self-employed customers to the same standard as for the employed. Customers must provide verifiable evidence of income and the rules allow for this to be demonstrated through past accounts, and for it to be prospective, e.g. projections from a credible business plan. There are also no MMR linked requirements in terms of the length of self-employment. Our data shows that lending to the self-employed has remained relatively stable since 2010 with MMR having no discernible impact in the current market. In 2014, lending to the self- employed totalled 98,493, 3% higher than the year before and higher than any time since 2010.
5.10 Credit impaired (Chart 7) – before the crisis, customers with poor credit and on low incomes were able to obtain mortgages via the non-bank/specialist lending sector. These loans were often securitized. The wholesale markets for non-mainstream business post crisis have disappeared and while we have seen a few lenders slowly re-entering this space, none are now prepared to lend to non-creditworthy customers because of the difficulty in accessing wholesale funding for impaired loans. The MMR changes ensure that even when there is greater availability of wholesale funding, lending is still restricted to those who can afford to repay. As a consequence, consumers previously served by these lenders can no longer access mortgage finance. Also, many who did obtain mortgages are now unable to access a new mortgage because their lender is no longer active and other lenders cannot or do not want to lend to them because of their poor credit history.
5.11 For the credit-impaired, the need for lenders to carry out a robust affordability assessment combined with the lack of availability of interest only mortgages is having an impact. However, our rules aim to avoid the detriment arising where consumers take out mortgages they cannot afford, a measure which drew strong support from consumer organisations. If the customer has a poor credit history but is able to pass the affordability assessment, our rules are not intended to restrict access.
