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Short circuit

The sub-prime mortgage market was always expected to be the source of most problems after regulation but the FSA also has misgivings about the prime sector.

In assessing the effectiveness of its mortgage regime with mystery shopping and both qualitative and quanti-tative consumer research, the FSA has given itself a pat on the back by insisting that its regulation is working. But it has also discovered what it calls a potential “payment shock” for borr-owers on short-term deals.

The FSA’s probe focused entirely on the prime market although it will follow up this work with a similar study next year into areas where it considers consumer detriment may be higher such as the sub-prime and lifetime mortgage markets and arrears management.

The latest investigation found that 41 per cent of consumers choose a mortgage on price but too often focus on the initial payments of a discounted deal and fail to budget for the payment shock once the rate soars, typically after two years.

The FSA does not specif-ically blast lenders but the implication is clear that it has a problem where borrowers are enticed by such deals.

Purely Mortgages chief executive Mark Chilton says: “The worrying thing is the resurgence of step-rate mortgages. They can be valid for people with short-term cashflow problems such as after a divorce but others are opting for them because of their price. They are bad news for 95 per cent of people. A broker can only advise people but we cannot tell them what to buy although it is mainly a problem in the direct market.”

Savills Private Finance associate director Melanie Bien says: “Even though it is the wish of the Government and the FSA for consumers to take out longer-term fixed-rate mortgages, these have not been embraced by the public. Two-year fixes are still the most popular type of fixed-rate product, partly because the rates are lower than on longer-term fixes.

“Products that are cheap initially but then rocket in cost are not suitable for those on a tight budget. This is where the value of a broker lies. The intermediary needs to explain not only what the initial payments will be but also what to expect further down the line.”

In fact, SPF has been at the centre of the debate over low-rate mortgages in the past few weeks after managing director Mark Harris called for best-buy tables to ban loans that include low rates with sky-high arrangement fees as they are misleading.

It is a different point to the one that the FSA is making but the principle is similar in that lenders are promoting cheap deals that draw borrowers in without them understanding the true cost.

But not everyone is in agreement with the FSA. Alliance & Leicester head of mortgage intermediaries Mehrdad Yousefi says: “The average life of a mortgage is two-and-a-half years rather than seven years, which was the norm in the 1990s. Consumers are more aware of the price of a mortgage. The proportion of mortgages on a standard variable rate is also shrinking fast as only 11 per cent are on SVRs.”

Legal & General housing direct Stephen Smith says: “I would have thought that people who buy a short-term deal are fully aware that they need to change further down the line. Lenders are also paying more attention to retention and brokers are now being remunerated for retaining clients so if there was a problem of customers getting a payment shock, that is likely to shrink. There is also the issue that the likes of Nationwide and Halifax offer the same deals to new and existing customers so there is more choice.”

Smith’s point about retention is also raised by the FSA. It reveals that since regulation, 23 per cent of consumers have remortgaged with the same lender compared with 16 per cent in 2003. Encouragingly for brokers, the research found that 57 per cent of consumers use an intermediary compared with 42 per cent in 2003.

Part of the reason for rising retention rates as well as lenders’ focus on retention is the rising costs of exit and set-up fees. Arrangement costs have rocketed from an average of 281 in 2003 to 430 in 2005. Exit charges have soared even more, from an average 98 in 2003 to 184 last year.

Average APRs rose by just over 1 per cent from early 2004 to early 2005. Although this was in line with a similar base rate rise during that period, the FSA, which says the variety of mortgages has increased since M-Day, insists: “Firms have passed on additional costs of regulation to borrowers.”

Chase de Vere Mortgage Management director Nick Gardner says: “The cost of mortgages was always going to rise because of regulation. Lenders have also ramped up their fees to subsidise their headline rates of interest, which has in itself made it much more difficult to calculate what the best deal is for what different sizes of mortgage.”

The FSA also shed more light on well-documented problems with disclosure, with particular issues around phone sales practices. It found that initial disclosure documents were issued by intermediaries in 73 per cent of face-to-face interviews where required but only in 28 per cent of phone interviews.

Despite some of the issues raised, the FSA has no plans to alter its mortgage conduct of business rulebook.

Chilton says any FSA action to limit the number of introductory deals would reduce consumer choice.

The regulator says: “The regime is operating effectively where firms comply but there are pockets of non-compliance relating to some basic disclosure requirements.”

This study has provided plenty of food for thought but it is likely to be a drop in the ocean compared with next year’s probe into regulation in the high-risk sub-prime and lifetime mortgage markets.

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About 15 years ago, shortly after becoming a journalist on this newspaper, I had an interview with a life office senior executive.

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