The second charge mortgage market has always been known for its specialist edge and the ability of lenders to think outside of the box – but is this about to change under the new regulator?
Alan Cleary, managing director of Precise Mortgages, has been outspoken recently about how he believes lenders will have to change their ways when it comes to affordability assessments – but is this the case, and if so how will it change the market?
A Knock-on Effect
Lenders’ affordability measures have been a hot topic in the mainstream mortgage market of late. In June the Bank of England’s Financial Policy Committee announced that lending to borrowers at over four and a half times their income should only make up 15% of bank and building societies new mortgage lending.
On top of this it wants to see lenders stress test borrowers to make sure they can handle a 3% rise in whatever the prevailing Bank base rate is at the time of lending.
Precise Mortgages currently uses an affordability model which stress tests the first and second charge for future rises in interest rates.
The final rules for the second charge market are still being drawn up; but Cleary believes it is only a matter of time before the same affordability tests that apply to the mortgage market will apply to seconds.
He says: “If CONC aligns with MCOB which is our working assumption, affordability will be key. Loan-to-Income will be defunct and those lenders who are not even bothering with LTI will not be able to get away with it.”
Cleary thinks all second charge lenders should be carrying out LTI checks at the very least and that under the new regulator they should also be carrying out affordability assessments and stress testing the loan against future interest rate rises.
He also believes that some lenders who do have LTI assessments in place are lending up to 9 times a borrower’s income in some circumstances, which he says is ‘questionable’.
Matt Tristram, director and co-founder at second charge lender Clearly Loans, says he has read Cleary’s comments with interest – he says: “Clearly Loans has one of the strictest affordability calculations in the entire industry.
“It’s clear from Alan’s comments that Precise have a direction it wishes to take its lending. As an FCA regulated mortgage lender it has to ensure all elements of its lending follow the same rules, whereas other lenders are solely second charge lenders, and therefore follow the guidelines applicable to them.”
Tristram says many lenders have made significant improvements in recent years regarding affordability and the record low level of repossessions in the sector are evidence of this.
In fact the most recent figures from the Finance & Leasing Association show there was a 43.4% fall in second-charge mortgage repossessions in Q1 of 2014, compared with the same period last year.
Steve Walker, managing director of Promise Solutions, says that if a lender in the seconds market does not carry out a full affordability check then most brokers will do it as a matter of course anyway.
He says: “If a lender doesn’t have an affordability check we will do one behind the scenes ourselves to make sure we are happy with the case, even if the lender says it will take it. The Mortgage Market Review hasn’t happened in the second industry yet but a prudent lender or a prudent broker should be applying similar principles anyway.”
Simon Stern, business development director at Prestige Finance, also says any reputable second charge lender will already have affordability models in place.
He says: “OneSavings Bank and ourselves are constantly reviewing our income and affordability model and will continue to do so in the future.
“We are all now awaiting the FCA and HMT consultation papers on the draft rules for implementing the Mortgage Credit Directive, which will hopefully be published in September and which are likely to have an impact on affordability models in the future.”
Aligning the Markets
Repossessions might be low in the second market but ultimately it will be the FCA that will lay down the rules around affordability.
Robert Sinclair, chief executive of the Association of Finance Brokers, expects the second market to evolve during the next 20 months and for the regulator to impose a more prescribed set of rules on firms.
He says: “The rules within the mortgage regime are much more detailed than anything that was ever set out under the Consumer Credit regime.
“As we go through the next 20 months and move from where we are now to the full FCA regulation I think the market will evolve and develop; and lenders will be helped by the FCA giving them more detailed rules.”
He says the principles under the Office of Fair Trading were always that firms had to lend responsibly but there has never been any specific rules for the sector like those under the MMR.
He says it looks increasingly likely that seconds will also fall under MCOB and he can’t see why the same rules around things such as stress testing would not apply to both markets.
“I can’t see any reason why the FCA would take a different view between a first and second charge loan,” he says.
Losing its Edge
Would such prescribed rules for the sector restrict the ability of lenders to help those who may have been turned away from the mainstream mortgage market though and force them to reign in some of their specialist criteria?
Whilst more onerous affordability assessments may restrict who they can lend to, Walker believes lenders will keep their specialist edge because of the size of the second charge lenders compared to those in the first-charge market.
“As long as regulation doesn’t force the smaller lenders out I think you are still going to have lenders who take customers on a case to case basis.
“The seconds market is more manually underwritten, which means you get better customer outcomes and a more sympathetic approach as you are not relying so much on technology to make the decision.”
Walker says at the moment all the lenders have criteria they work to but that most of them are willing to look at a case if it makes sense to lend.
He says: “They might be taking on greater risk but they are smaller lenders, so the exposure isn’t so great.”
The ability of second charge lenders to look at cases on a more personal basis means that they can control how much business they choose to lend to those at higher LTIs and to borrowers who may not necessarily look good on paper– as it is ultimately them taking the risk.
Sinclair says: “If you are a first charge lender operating in the business today I think you can meet your lending target requirements without considering those people who might have some past credit issues.
“Second charge lenders have a different view of the world and for those who want to play in the space of considering those with some form of payment problems will proceed appropriately for the risk they think they are taking – which is very much a commercial decision.”
Nothing is for sure until the FCA releases its final rules for the sector. Up until that point firms will continue to speculate as to what the rules will contain and how they will change the market. While it is safe to assume that the regulator is planning to align the seconds market with the first as much as it can, it is also expected that it will recognise that a second charge loan is different from a first charge loan in many respects and make allowances for this in its final rulings.