The FCA has issued the terms of reference for its mortgage market study, which has been focussed more tightly since it issued its feedback statement in May 2016. The review will now revolve around the consideration of two key questions:
- At each stage of the consumer journey, do the available tools (including advice) help mortgage consumers make effective decisions?
- Do commercial arrangements between lenders, brokers and other players lead to conflicts of interest or misaligned incentives to the detriment of consumers?
However before diving into the detail it is important to ensure that the scope of the study is accurate.
In order to frame the size of the first charge residential mortgage market, the amount of product transfer volumes should be included and there needs to be an understanding of the proportion of advised sales compared to execution-only transactions. This affects the starting point of the study and without this any perception of an imbalance between distribution channels is skewed.
Current market estimates put the annual turnover figure for product transfers between £80 billion and £100 billion, in addition to the reported £240bn of gross lending currently in CML data. With approximately 85% of these product transfers being transacted directly with lenders and on an execution-only basis, this has a very different profile. This means that more than a third of the entire residential mortgage market is unrecorded as lenders refuse to disclose the precise scale of this lending.
Customers face potential detriment as straightforward product transfers do not always trigger a revaluation, affecting LTV, rate and affordability. Some lenders in their desire to retain existing customers are sending limited product transfer offers, not from their whole product range, which limits customers’ abilities to make informed decisions.
Some lenders are incentivising customers to switch products before the end of the initial term which could be to the customer’s detriment. A customer may have been recommended to pay an arrangement fee for a two year fixed interest product but is given the option to switch products after 18 months. As customers often choose to add fees to the mortgage, by switching earlier these fees are compounded in a shorter period of time, which the customer is unlikely to be made aware of. This can also impact any advice given on the original product. An intermediary would recommend a product on the basis that it is the most suitable with the costs over the full initial term being taken into account. A product with an arrangement fee may have been recommended instead of one without a fee because of the lower monthly payments. By switching products early the initial advice is compromised.
These incentives can also limit customer choice. Because some of the offers are being made so far in advance of the end of the initial term, customers are unable to shop around and compare against other products as these are not available as an early repayment charge would be payable if they exercised early. We hope that the study will look at this as a starting point in its deliberations.
Consumers and effective decision making
Consumers have experienced, and become accustomed to, declining mortgage interest rates for the last eight years. This need to be taken into account when making assessments around consumer behaviour as these risk being flawed if limited to the last decade.
Some lenders are still unnecessarily denying borrowers’ access to mortgage products or lower rates which should be allowed under the FCA’s MMR porting and transitional rules. In addition some borrowers cannot access mortgage products specifically as a result of the application by lenders of a rigid interpretation of the MMR affordability requirements.
A mortgage is a significant purchase point in terms of its value, term and frequency of ‘renewal’. The importance of shopping around for a customer when purchasing a one year contents insurance policy is magnified when a customer seeks to purchase a five year fix within a 25 year term mortgage. The FCA responsible lending review even admitted that how much a customer can borrow “can vary considerably from lender to lender”. We think that this review should consider whether this market needs encouragement to “shop-around” which matches the encouragements now required in the general insurance and annuity markets.
The range of products offered matches the greatly differing and complex needs and circumstances of consumers. Because there is such a choice of suitable products, prices are competitive. By delivering this wide range of products based on such variables as LTV, individual risk profile, employment characteristics or type of property, the rate can be varied according to risk meaning there is less cross-subsidisation. Whilst simplification of product may benefit a few types of customer, it will marginalise a large segment of the market.
All markets need their customers to be informed. This shouldn’t just be with regard to products but also service. It is important for customers to understand whether they are receiving advice or not and the limitations of execution only, as well as the role of any adviser in assisting the whole transaction to completion.
The role of the intermediary
Intermediaries give customers product choice. The difference between advice from an intermediary and advice from a lender is the limitation in products, which in turn affects customer outcomes. If the majority of, or all, consumers obtained mortgage products (either advised or non-advised) directly from lenders, there is a higher chance that lenders will be less competitive. In evidence from the former Deputy Chairman of Santander Group to the Treasury Select Committee in 2010, he set out that the UK model with a high intermediary focus ensured that lenders delivered more competitive products than was the case in other jurisdictions.
Sourcing systems are a research tool and complement intermediaries’ all-round knowledge of lenders and products in the market. Both intermediaries and lenders know that there are issues with accuracy and reliability. Sourcing systems only capture lenders’ published criteria; whilst intermediaries will know when a lender will be able to step outside of their criteria for a particular customer.
Concerns around intermediaries using panels of lenders and the impact on customer access to the right products are realistic. However, intermediaries give customers a wider choice of products than lenders, who are essentially a panel of one. If a product from a lender off-panel is more suitable for a customer, an intermediary will have processes in place to be able to still make this recommendation.
The role of advice
The quality of advice from lenders and intermediaries is likely to be similar, but the difference is in the customer outcome as lenders can only advise on their limited product set.
Advisers, both in lenders and intermediaries, ask sufficient questions of customers to objectively assess needs and circumstances. They probe and challenge customers when they express conflicting preferences or have conflicting needs. Advisers consider and discuss potential trade-offs with customers and help them to establish priorities and understand the consequences of decisions. Advice is a valuable tool for consumers in their decision making.
Research has identified that customers may not be best placed to identify the most appropriate product because they tend to place excessive focus on short-term costs and have a potentially over-optimistic view of what the mortgage market and their financial situation might look like in the future. There are many outside factors that influence customer behaviour including best buy tables and press coverage. Consumer optimism is also difficult to address. The current complexity of suitability, the range of lenders and products means that the ideal scenario of customers being able to make all financial decisions themselves without advice looks difficult.
The lack of advice can lead to an unsuitable product as there is no ability to recognise any flexibility in the consumer’s circumstances, such as a consumer who could afford to increase their equity by using savings (even by a small amount) which would result in being eligible for a product with a lower LTV, lower interest rate and overall lower cost.
Genuine execution-only can be appropriate for a proportion of customers. However customers do not always know they are not receiving advice. This risk becomes more acute with customers who are financially incentivised to switch products without knowing the limitations, or those who are offered a limited number of products but under the guise of execution only.
Anything that dilutes the opportunity for customers to benefit from advice, which includes the protections afforded by the Financial Ombudsman Scheme and Financial Services Compensation Scheme, risks moving the market significantly backwards.
This is an important study which impacts a significant market. Any issues arising and possible remedies will need to ensure that it moves the market forward for the majority. Engagement of all will be critical.