Sub prime mortgages
As sub prime is a growing section of the mortgage market, it has been identified as an area in which the FSA should assess the appropriateness of advised sales.
The phrase 'sub prime' in relation to mortgages, sometimes also referred to as "non conforming mortgages", generally refers to those mortgages targeted at consumers with impaired or low credit ratings who may find it difficult to obtain finance from traditional sources. These mortgages are also often used to consolidate existing [secured and non-secured] debts.
We wanted to assess whether mortgage advisers are taking reasonable steps to ensure that personal recommendations to enter into sub prime mortgage products are appropriate to the needs and circumstances of consumers and to ensure that mortgage advisers are gathering all information likely to be relevant for the purpose of establishing the suitability of these products.
In recommending regulated sub prime mortgage products, our mortgage conduct of business rules require firms to obtain sufficient information from the customer and to take reasonable steps to ensure that personal recommendations are suitable.
We visited a sample of 31 small mortgage firms focusing on the sale of sub prime products, looking at their sales processes and reviewed a total of 210 customer files.
What did we find?
Obtaining client information:
We found that in 60% of files reviewed insufficient information was obtained about the customer in key areas considered to be relevant to the sales of sub prime mortgage products. Further information on what we consider to be key areas for sub prime is provided below.
Demonstrating suitability:
57% of the total client files we reviewed involved consolidation of a customer's existing debts. Where a main purpose of the mortgage is to consolidate existing debts there are additional factors which firms giving advice must take into account.
These factors include:
- the costs associated with increasing the period over which debt is to be repaid;
- whether it is appropriate for the customer to secure a previously unsecured loan; and
- whether it would be more appropriate for the customer to negotiate an arrangement with existing creditors (where the customer is known to have payment difficulties).
In 33% of the files firms were able to demonstrate that they had taken account of these factors when consolidating consumers' existing debts into a new regulated mortgage contract. However in 67%, firms were unable to demonstrate they had taken account of the factors.
In addition, in 80% of files reviewed, there was a lack of evidence to demonstrate how the recommended sub prime product meets the customer's needs and circumstances.
Some firms were able to rationalise the recommendation of a sub prime mortgage product by providing further information verbally about the consumer's circumstances which were not always recorded on the file. Therefore this may suggest that the issue is a lack of record keeping rather than an issue about the suitability of the advice or any consumer detriment.
Industry Practices
Keeping in contact with customers:
Firms were asked about their intentions to review a consumer's sub prime mortgage product to see whether that consumer could transfer onto a prime mortgage contract at market lending rates at some point in the future. Our conduct of business rules do not require firms to carry out such a review, but we were encouraged to hear that 58% of firms stated that they were going beyond our requirements and would review a consumer's sub prime mortgage product at some point in the future once their credit profile has improved.
Suitability letters:
65% of the total firms visited stated their practice is to issue a suitability letter to a consumer outlining the reasons for their recommendation. In some cases the suitability letter was used to explain the implications to the customer of taking a mortgage on an Interest Only basis. In such cases, the letter often highlighted the implications to the customer such as:
- the need to still repay the capital element;
- the reduced term available to repay the loan; and
- the payment shock that could follow on switch to a capital and interest repayment method in subsequent years.
Again, this goes beyond our specific requirements but we were encouraged that some firms were recording and explaining the implications of interest only loans in these letters.
Things that firms need to be aware of
Obtaining client information:
In addition to the information gathered from a customer involving the sale of a prime mortgage product, firms must ensure that they gather sufficient information in certain areas to demonstrate suitability of a sub prime product. All information gathered for the purpose of assessing suitability should be recorded. The FSA is reminding mortgage brokers that they need to have regard to all relevant facts about a customer of which they should reasonably be aware when selling a sub prime mortgage product, as well as those that a customer has disclosed him/herself. Firms must determine what is relevant when dealing with each customer, but the following will often be important aspects of a customer's circumstances where sub prime mortgages are being considered:
- the customer's credit history including an awareness of the customer's debt position;
- details of any existing mortgage arrangements; and
- income and expenditure information to assess affordability.
Firms could ask customers to bring information to assist the fact finding process and we intend to encourage customers to do this through our consumer messages in October.
Suitability:
Firms must recommend a suitable and affordable mortgage product capable of meeting the customer's needs.
Based on our findings in the area of debt consolidation, firms should review their procedures to ensure all relevant factors are considered particularly given the types of customers involved. We do not prescribe particular systems and controls, but some examples of measures which firms could consider are:
- Use of a fact find document to evidence that all requirements have been discussed and considered with the customer.
- Completing a checklist as a means of demonstrating that additional considerations have been reviewed with the customer.
The action we have taken and what we intend to do in this area in the future.
Individual feedback has been provided to all firms that took part in the project. In some cases, it has been necessary to enter into further correspondence with firms.
Our review identified three brokers who appear to have assisted customers in obtaining a mortgage when their income would not meet the lender's criteria, for example by inflating income on the application form. These firms have been referred to Enforcement for further investigation.
Follow up work is planned in the future which will further assess advised sales of sub prime mortgage products, focusing on the areas where we considered that insufficient information was recorded for sub prime sales. We will assess whether firms have changed their procedures for gathering all relevant information for sub prime sales based on the findings from this project.
