With the provision of independent advice at the core of the mortgage intermediary’s service offering, the Financial Services Authority’s (FSA) draft rules on advised sales need close attention. Based on these drafts, there are a number of things that we can deduce about giving advice from 31 October 2004.
The regulatory definition of advice is something that is given to a person in their capacity as a borrower or potential borrower. It is advice if it is based on a discussion of the merits of the client entering into a particular regulated mortgage contract (‘mortgage’), or varying the terms of said mortgage in such a way to vary the borrower’s obligations under that mortgage.
Varying the terms of the mortgage includes advising on further advances, a rate or product switch (but without changing lender), and transferring from a repayment mortgage to an interest only mortgage.
So for advice to be a regulated activity it has to relate to a particular mortgage contract and be given to a person in their capacity as a borrower or potential borrower. To be advice it cannot just be information and it must relate to the merits of the borrower entering into (or varying the terms of) the mortgage.
Suitable advice
Advice can be given face to face, orally, to a group, by telephone, by correspondence (including email), in a publication, broadcast or website, or through the provision of an interactive software system.
Advice would not relate to a particular contract if it consisted of a recommendation that a person should take out a mortgage with ABC Building Society without specifying what kind of mortgage. Equally, just recommending that a client take out a variable rate mortgage is not advice.
The rules on suitable advice, MCOB 4.5.2 R, state that a firm must take reasonable steps to ensure that it does not make a personal recommendation to a client to enter into a regulated mortgage contract, or vary an existing regulated mortgage contract, unless the regulated mortgage contract is (or after the variation will be) suitable for that client.
There are three elements to meeting the rules on suitability. Based on the information given by a client in a fact find document, and the information advisers should be reasonably aware of, there needs to be good grounds to conclude that the client can afford the mortgage and the mortgage is appropriate to their needs and circumstances. In addition, that the mortgage is the most suitable of those that the adviser has access to.
If there is not a product that a broker can offer or have access to that is appropriate to the needs and circumstances of the client, then no recommendation must be given.
When assessing the client’s affordability for the mortgage, advisers must explain that this is based on current interest rates (which may rise in the future) and the client’s current circumstances (which might change in the future). Brokers should take into account the information the client provides about their income and expenditure (plus any other resources), any likely change to his income, expenditure or resources; and the potential effect of payment shock once any discounted period ends.
When assessing whether the mortgage is appropriate to the needs and circumstances of the client, brokers should give due regard to the whether the client is eligible for the mortgage ‘for example whether it fits the lender’s LTV criteria, and whether they should have an interest-only or repayment mortgage or a combination of both. In addition, they need to establish whether they intend to make early repayments, whether they have a preference or need for payments to be reduced at the outset (a discount mortgage for example), whether they have a preference or need for stability in the amount of required payments (a fixed rate mortgage for example), and whether they have a preference or need for any other features such as payment holidays.
Out of the products that are identified as being appropriate for the client, the broker should recommend the one that is the least expensive, taking into account those pricing elements identified by the client as being most important to them. Importantly, this requirement is likely to be extended by the FSA, as a result of its latest consultation, so that brokers can hopefully take into account other criteria such as speed and quality of service of the lender.
However, for those with access to ‘exclusive products’ beware. A product will not be more suitable than another simply because it is available at a more favourable price through an alternative distribution channel or on special terms and its availability is restricted. Any product recommended must be suitable to the client regardless of how good it is.
Acting appropriately
Where an adviser makes a recommendation to a client for the purposes of consolidating existing debts into one loan amount they must take into account the costs associated with increasing the period over which a debt is to be repaid and whether it is appropriate for the client to secure a previously unsecured loan. Furthermore, advisers need to check whether it would be more appropriate for the client to negotiate an arrangement with their creditors than to take out a regulated mortgage contract.
There is no requirement for a ‘suitability letter’ but brokers are required to make and retain a record of the client’s information, including that relating to the needs and circumstances; and the reasons why you concluded that any personal recommendation satisfies the suitability requirements.
The FSA is currently consulting in CP186 on how long these records must be maintained.
