First charge mortgages are now under the regulation of the Financial Services Authority (FSA), but second charge mortgages – or secured loans – remain outside this regime.

In the consumer credit sector, regulation has been commonplace since before the Consumer Credit Act 1974 (CCA). The sector includes hire purchase, car finance, credit cards and personal loans – both unsecured and secured. The latter is often known as a second charge because a charge is taken over the property following the first mortgage – but other than this, the loan is completely different to a mortgage.

Mortgage Day saw a host of changes implemented, including the introduction of new regulations for adverts. These were produced as part of the FSA’s rules, but they also have had an impact on the consumer credit market.

For example, the new regulations set out the circumstances in which an APR must be displayed in an advert. These include the APR being printed one-and-a-half times the size of other financial information, located with the other financial information, and stating whether it is variable or not.

In addition, the so-called ‘from’ APR should be based on at least 10% of the business written and must be accompanied in an advert by the corresponding highest rate – known as the ‘to’ APR – which is charged on any of the credit agreements entered into as a result of the advert. For example, if a broker places an advert for secured loans, but refers to unsecured loans with a higher rate to a third party, the higher rate must also be included.

Rate calculations

At first glance, a typical APR seems straightforward, but it is the APR at or below which the advertiser reasonably expects credit would be provided to at least 66% of the target audience who enter into credit agreements that matters.

For example, if the from APR is 8% and the to APR is 13%, the typical APR might be 11%. This is based on previous experience of receiving business based on the advert. However, the Office of Fair Trading (OFT) has sought to clarify this so-called 66% rule by adding that the typical APR is defined by reference to reasonable expectations at the date on which an advert is published – such expectations may be based in part on past performance, but this cannot be the only consideration.

The issue of adverts containing repayment tables – which are known as step banded adverts – has also been addressed by the OFT. The tables are allowed, subject to the use of a single typical APR and the ‘to and from’ APRs. Care must be taken to ensure the rates quoted are not misleading contrary to Section 46 of the CCA, which states that an advert must not convey information which in a material respect is false or misleading.

The wealth warnings for secured loans have also changed to the statement: “Your home may be repossessed if you do not keep up repayments on a mortgage or any other debt secured on it.” This wording is slightly different from MCOB promotional requirements and needs to appear in upper case letters.

If any element of debt consolidation is being offered in an advert, the wealth warning must be preceded by: “Think carefully before securing other debts against your home.”

The requirement to state loans secured on property is under debate at the moment. One school of thought is that where there is a wealth warning on a secured loan advert the statement is not required.

On 31 May 2005, three other regulations will come into force, covering disclosure of information, agreements and early settlement.

The first is a completely new set of regulations, while the second and third are replacing existing CCA regulations. The aim of these is to ensure greater transparency for consumers in the way credit products are compared and sold. However a date for regulations governing online agreements has not yet been set.

The new pre-contract disclosure rules will ensure that all essential terms of a contract are revealed to a consumer up front, irrespective of whether or not the agreement can be cancelled. The new regulations do not apply to agreements to which Section 58 of the CCA apply, such as secured loan agreements with their standard cooling-off periods.

The major change affecting the secured loan area is in relation to the form and content of the credit agreement with the consumer. The existing requirements are set out in the Consumer Credit (Agreements) Regulations 1983 and are so complicated they make it difficult for lenders to provide consumer-friendly information.

Under new requirements, examples must be given of the costs of settling an agreement early. The figures must show the amount that would be payable if the loan was redeemed when a quarter of the term of the agreement elapses, one half of the term elapses, and three quarters of the term elapses – or the first repayment date after each of those dates.

The agreement must also include the following statement about missing payments: “Missing payments could have severe consequences and make obtaining more credit difficult.”

The final major change due next May is to do with early settlement. The new regulations replace the Consumer Credit (Rebate on Early Settlement) Regulations 1983, and with it the rebate formula known as the Rule of 78 or the sum of digits method. This calculation was appropriate for short-term fixed interest credit, but was inappropriate for longer-term credit agreements. The calculation created a situation where a borrower redeeming in the early months of taking out an agreement paid very little, while after 12 months the payment was capable of rising to as much as the equivalent of more than 10 months’ interest. As a result, lenders often capped the maximum charge at six months.

The new CCA regulations introduce an actuarial style outcome as far as the borrower is concerned. It offers a 28-day deferment period if the agreement is more than a one-year term, in which case the lender can add a further one month’s interest. However, all interest is added to the loan at the outset and, therefore, on early settlement, so the lender is rebating the uncharged interest.

Under the new arrangement, lenders must respond to a settlement statement request within seven working days.

Looking ahead

In the future, many industry commentators are hoping for changes to a number of areas including changes to online agreements. Changes that are being implemented under CCA requirements include the abolition of a £25,000 limit on consumer lending – although this will be retained for business borrowing by individuals and small partnerships – the implementation of the European Consumer Credit Directive, changes to Section 127 of the CCA – which can make an agreement not only unenforceable, but also invalid – and an opt-out clause for high-net-worth individuals.

The mortgage industry has seen huge changes this year in how it is governed with the introduction of FSA regulation, and while this momentum of change has eased for the time being, more is coming during the course of next year for those involved in the secured loans market. As with FSA regulation of mortgages, consumer awareness of these CCA changes will probably be minimal even though they are the intended primary beneficiaries.

key points

Second charge mortgages or secured loans remain outside the FSA’s new regulations.

The FSA’s new regulations for adverts will have a significant impact on the consumer credit market.

Experts are hoping for changes to a number of areas, including changes to online agreements.