Prior to the introduction of Mortgage Credit Directive (MCD) on 21 March 2016, second charge secured loans were regulated as consumer credit and governed by the Office of Fair Trading (OFT).
The outcome of a lengthy and broad consultation by the Financial Conduct Authority (FCA), commencing in September 2014, confirmed that intermediaries, lenders and trade associations largely supported a new regulator and regulatory framework to replace archaic consumer credit law and an ineffective OFT.
The Consumer Credit Act 1974 and 2006, which provided regulatory policy for secured loans, introduced some consumer protections, but was also inadvertently responsible for the creation of increased intermediation and inflated fees. MCD has improved the second charge mortgage industry, but completion numbers are lower despite substantial reductions in interest rates.
FCA regulation of 'seconds' has changed the market, with both current and future relevance.
Being involved in the distribution of secured loans from the mid-1990s to 2006 was a license to print money. For much of this period it remained unregulated with ubiquitous self-certification of income, 125 per cent loan-to-value and commissions circa 10 per cent plus high percentage broker fees. Many multi-millionaires were created.
Distribution in this period was controlled by “packagers”, so called for being a conduit between lender, broker and borrower; responsible for issuing loan documents, obtaining proof of income and instructing valuations – basically organising a full file for submission to a lender so they could review it internally and complete an application.
The advantage for lenders was being in control of operational costs in a market that had historically grown and contracted dramatically as a result of recession and subsequent property booms. In most cases a customer experience would involve applying for remortgage and being told they either “did not qualify” or that a secured loan was a better option for a number of reasons.
Their mortgage broker, however, was unable to apply directly to a secured loan lender as distribution was limited to a small panel of packagers, at its peak perhaps 30 to 40 companies nationally.
Consumer credit law was responsible for creating the packager. The Consumer Credit Act did not allow for intermediaries or lenders to charge proposed borrowers any upfront fees – this extends to application fees in addition to advice fees.
Therefore, borrowers were unable to pay for valuation fees, third party reference costs, lender fees, or broker fees. Valuation and third party fees such as consent to a second charge must be paid upfront as both surveyor and first charge mortgagee require payment prior to completion.
As a result, substantial upfront fees were required to be paid, and borrowers were restricted by law from picking up the bill. Conflicted lenders found it difficult to determine what borrower estimates of property value were accurate and were exposed to potential loss should the estimate prove to be too high.
Mortgage brokers were used to dealing with first charge lending where a client either received a free valuation or could pay upon application and had no desire to risk personal money on a client with no guarantee of future success and commission. To solve this problem the packager was born; a third party administration and underwriting function acting in partnership with a lender whereby they were quite happy to underwrite up-front application costs.
