In September the European Commission issued a final consultation document for the Consumer Credit Directive, which could have serious side effects on the mortgage market in the UK.
In its current format, the proposals could strangle the provision of the UK’s most popular mortgage ‘ the flexible mortgage ‘ by making it too restrictive to align the product with the proposed EU rules, as well as existing FSA requirements.
The new Consumer Credit Directive, while not specifically addressing mortgages, is designed to harmonise consumer credit across Europe so has laudable intentions. But the Directive could see UK borrowers at a serious disadvantage if it goes ahead in its current form.
Within the UK, remortgages and equity release products would also be interpreted as falling within the scope of the directive.
Both of these are growing trends within financial services industry in the UK, accounting for over one-third of lending between them. In addition, as it currently stands, even if a loan is outside the scope of the Directive ‘ for example, a mortgage for house purchase ‘ but a borrower requests a credit drawdown facility on that mortgage, then the mortgage would come under the Directive.
This means that for flexible mortgages, every drawdown would need to comply with the consumer credit requirements ‘ as well as FSA rules.
This would place impossible legislative restrictions on lenders and would place too much red tape around such mortgages in the future, making them unattractive for lenders and borrowers alike as they would have to approve a new credit agreement each time they wanted to use the facilities of the mortgage.
Bad news for the British
This is bad news for UK consumers. At the start of 2002, the Council of Mortgage Lenders (CML) was quoted as saying some 16% of all mortgages could be classed as flexible.
Research commissioned by the CML and the Office of the Deputy Prime Minister indicated the rapid growth of flexible loans was expected to continue and borrowers generally compared them more favourably to traditional mortgages.
This research indicated that the current low interest rates were helping many borrowers with flexible mortgages to achieve large savings by overpaying their loans by up to 100% each month, with a quarter either doubling their regular monthly repayments, or paying one-off lump sums to reduce their mortgage.
The research also found nearly one in five flexible borrowers had used it to draw upon equity from their home ‘ usually by withdrawing a single lump sum. This was widely regarded as a cheap loan for home maintenance, to clear other debts, or to spend on goods and services.
Under the new EU Directive, this type of drawdown would be surrounded by time-consuming paperwork and legal checks making it an unattractive option for lenders and borrowers.
The regrettable aspect is that flexible mortgages evolved to help consumers deal with modern life.
Historically, people grew up, left school and started work ‘ where they stayed until they retired. During this time they also got married, started a family and the cycle started again.
Times have changed and there is no such thing as a ‘job for life.’ In fact, even a ‘career for life’ is becoming a rarity with people changing career three times during their lifetime on average. All this uncertainty means people do not want a financial millstone round their neck. They need a mortgage that can move alongside the peaks and troughs of their own life.
Lenders only used to lend money to people who had been saving with them for many years. Getting a mortgage involved a meeting with the local bank or building society manager where their financial prowess would be scrutinised with a fine toothcomb before any loan could be granted.
However, increasing competition in the banking industry and rapid developments in technology means lenders now have to evolve to find success in the modern consumer society.
For example, the phenomenal growth of the internet not only enables lenders to increase their service, but also provides a useful tool for consumers wanting to know more about the financial products and providers available. The internet enables easy comparison of products and brings a visibility that has not been available in the financial services industry.
One of the results of this development was the ‘flexible mortgage’. There is no strict industry definition for a flexible mortgage as different lenders offer different features. The most frequently found elements are the ability to overpay or underpay, payment holidays and interest calculated daily.
However, the most sophisticated varieties also allow equity draw-down on the property. This enables borrowers to capitalise on the value of their property and get access to extra financing at mortgage rates ‘ which are far lower than personal loan rates.
UK lenders have invested significantly in promoting the benefits of equity release in marketing material, either direct with the consumer, or through professional mortgage advisers, and take-up of this flexible mortgage benefit is rapidly increasing.
However, the new EU guidelines could pour cold water on this growth by making it too difficult for lenders to provide this service for consumers.
The current guidelines also pose a threat to the remortgage market, which has taken off in the UK in recent years. The increasing portability of financial products means that borrowers have woken up to the fact they do not need to be harnessed by an uncompetitive mortgage for the full 25 years of the term. Without any restrictive tie-in penalties, consumers may save themselves thousands of pounds by investigating alternative mortgage deals within the market.
Figures issued by the CML demonstrate that remortgaging is a growth industry. Following an impressive figure (£6.9bn in May 2002), in June 2002 remortgaging totalled £5.6bn ‘ which compared to a value of £4.3bn in June 2001 shows remortgaging is a key focus for the mortgage industry.
Under the draft EU Directive on consumer credit, remortgages would be subject to even greater scrutiny and associated paperwork than they do at present. As well as slowing down the process and making it less appealing for consumers, this may have the effect of making lenders less willing to take this type of business.
However, it is still too early to begin panicking about this directive just yet. While it is a final draft, it is still a draft consultation document and, as part of the consultation exercise, the CML, on behalf of lenders, will be setting out the case for flexible mortgages to the European Commission. The UK mortgage market is far more innovative than others in Europe, so it would be a shame if that innovation was stifled by over-the-top legislation.
Nobody wants to see a return to the ‘boom and bust’ of the early 1990s, so it is unlikely UK lenders would like consumers to over-commit themselves in such a way they could not cope if rates began to rise.
The intentions of the European Commission may be good, but they are in danger of not giving consumers the freedom of choice they require. Consumers must be protected from getting into too much debt, but they should not need to go ‘cap in hand’ back to their lender whenever they require access to additional funds.
Equity drawdown simply enables a consumer to capitalise on the worth of their property to access additional funds. It is highly unlikely this type of borrowing would open the floodgates of debt.
The current proposals are an insult to UK consumers. Consumers must be given credit for having some intelligence over their own financial affairs.
Ian Jeffery is sales and marketing director at Intelligent Finance
As it stands, draw-down facilities would need a new consumer credit agreement each time they were used.
Remortgages and equity release schemes would also be caught in this, adding further time-consuming paperwork to the process.
The CML is taking the threat seriously although it should be remembered it is only a draft.