The financial watchdog is investigating several firms offering second charge mortgages after evidence emerged over lax lending standards.
It has come to light that borrowers have been able to overstate their incomes and still get approved for a loan.
It’s understood the regulator is concerned about self-employed borrowers being allowed effectively to self-certify their income using an accountant’s certificate – something that was banned on mainstream mortgages when the financial crisis hit in 2008.
Lenders are also understood not to be assessing affordability strictly enough, meaning borrowers who have taken a second mortgage may find themselves unable to meet monthly payments if interest rates go up.
Lehman Brothers went bust spectacularly in 2008 after buying up self-cert sub-prime loans
Mortgage advisers’ behaviour has also been questioned with some ‘master brokers’ reportedly charging borrowers second charge completion fees of up to 10 per cent – which amounts to £6,000 on a typical £60,000 second charge mortgage.
According to the latest figures from the Finance and Leasing Association, the trade body for second charge lenders, 21,288 people took out a second charge over the 12 months to the end of November last year. This was a 9 per cent rise on the previous year.
Many of these borrowers are financially vulnerable and take a second charge to consolidate other more expensive debts.
A spokeswoman for the Financial Conduct Authority said: ‘We can confirm that we are speaking to second charge firms to understand how they are complying with the affordability rules introduced in March 2016.’
Shawbrook apologises to borrowers
Shawbrook CEO Steve Pateman apologised
The FCA refused to comment on which firms were being investigated but challenger bank Shawbrook has confirmed it has been part of a multi-firm review by the FCA.
Following discussions with the FCA at the end of 2017, Shawbrook tightened up its lending criteria after the regulator found customers were suffering ‘disappointing outcomes’, according to the bank’s chief executive, Steve Pateman.
We haven’t done as good a job as we’d have liked and going forward, we are going to do better – Shawbrook chief exec
He admitted that mortgage brokers had ‘lost confidence’ in the lender, which was found to have done a poor job on underwriting second charge mortgage applications for the self-employed.
Preceding the FCA’s review, the lender was accepting an accountant’s certificate as sufficient evidence of income on second charges.
An accountant’s certificate is typically used by company directors whose self-assessment taxable income is not representative of their actual income.
This could be a result of taking large dividends out of the company or retaining profits within the company.
However, Pateman said the regulator found that, while this didn’t mean Shawbrook was ‘doing things wrong’, it did ask the bank to ‘tighten up income verification’.
What is a second charge mortgage?
A second charge mortgage, also known as a secured loan, is pretty much the same as a first charge mortgage.
The difference is that it is a separate and second contract between a homeowner and a mortgage lender where the homeowner already has a mortgage contract in place.
The second lender can agree to top up the loan a homeowner has secured against their property by taking what is called a second ‘charge’ against the property in exchange for a second mortgage.
It works in exactly the same way as a normal mortgage – there are monthly repayments due including interest.
That means if you fall behind, your home is still at risk of repossession.
The regulator also found evidence that Shawbrook was failing to stress borrowers’ ability to afford to repay their loan in the event of rising interest rates.
Pateman said: ‘How we considered stressing interest rates and income verification on our self-employed customers led to some poor decisions on our part.
‘We haven’t done as good a job as we’d have liked and going forward, we are going to do better.’
The bank’s crackdown on underwriting standards came as two senior directors recently quit the bank.
Last week, Shawbrook confirmed Maeve Ward was leaving ‘to pursue other career opportunities’; she played a key role in building Shawbrook’s second charge business and has been with the lender since 2009.
Stephen Johnson, deputy chief executive and one of the founding members of Shawbrook, left just weeks before to ‘take a career break’.
Since tightening up its approach to assessing second charge applications, Pateman said a number of borrowers who had previously been approved for a second mortgage had since been contacted and told they no longer qualified.
‘Clearly this has been a very unfortunate situation. Perhaps we haven’t done as well as I would have liked but that’s not to say we did anything wrong. Now we want to do better in a way that the regulator is happy with.’
The FCA has reportedly uncovered multiple examples of poor practice among lenders
What is the FCA investigating?
Following the early stages of its review, the FCA has reportedly uncovered multiple examples of poor practice among lenders.
In March 2016 rules called the European Mortgage Credit Directive were introduced forcing mortgage lenders to treat anyone borrowing a second charge mortgage with the same care and attention as someone borrowing a first charge loan.
In practice, this meant that lenders should have put in place affordability checks requiring borrowers to prove their income and expenditure before being approved for the loan.
It also meant that lenders had to check whether borrowers would still be able to afford their repayments if interest rates went up by 3 per cent.
And it required brokers to disclose their commissions and all fees up front – something they hadn’t previously had to do.
At the same time as these rules came in, the Office of Fair Trading was disbanded and the FCA started to regulate second charge mortgages in its place.
However, almost two years after these rules became law, the FCA has found evidence that lenders are still failing to check borrowers’ income sufficiently while advisers are continuing to charge astronomical fees.
Threats and vested interests
Blackwell: There are too many second charge firms continuing to act in the same old way, as if regulation hadn’t happened
Lynda Blackwell, who stepped down from the FCA at the end of last year having been mortgage manager, oversaw much of the implementation of the new mortgage rules in 2016.
She said: ‘Regulation was designed to level the playing field between the first and second charge markets, ensuring the same protections and better outcomes for customers.
‘There are too many second charge firms continuing to act in the same old way, as if regulation hadn’t happened.
‘The regulator has clearly had enough – and there are many in the industry itself starting to stand up against the poor practices which are doing so much damage to its reputation. Things need to change.’
Her comments echo others. This is Money has heard from multiple sources wishing to be kept anonymous, saying they are concerned about behaviour in the second charge market.
We have been told that anyone daring to challenge poor practice has been met with veiled threats.
Others have suggested there are people running second charge firms whose lifestyles now depend on being able to charge disproportionately high fees.
It’s understood these people wield enough commercial influence that they are putting pressure on those in the market who want to cut fees to the customer.
I’ve seen lenders accept eBay receipts as proof of income in this market.
One source said: ‘I’ve seen lenders accept eBay receipts as proof of income in this market.
‘The OFT was always a toothless tiger. It never enforced the rules that tell second charge lenders and brokers to treat customers fairly, so no one ever bothered to.
‘Now the FCA has taken over, it’s finding that a number of the people operating in this market are used to ignoring regulation and they’re still doing it. Until the FCA starts fining firms for bad practice, they are unlikely to change.’
Second mortgage advice fees also under the spotlight
Prior to march 2016, it was widely accepted that broker firms charged borrowers a completion fee of 10 per cent of the value of the mortgage.
On a £50,000 second charge loan this would be £5,000.
Brokers also earned – and still earn – commission of about 2 per cent of the loan value from the lender. A further £1,000 on the same loan.
Most brokers today claim these fees have come down dramatically, with the typical commission still at 2 per cent and borrowers charged a further 4 per cent.
But depending on which broker you use, these fees vary wildly.
A web of commercial interests
Networks negotiate advantageous commercial arrangements with other partner firms
Many smaller mortgage brokers operate as part of a network, with these larger firms responsible for making sure they comply with FCA regulation.
But networks also negotiate advantageous commercial arrangements with other partner firms including lenders, equity release providers, conveyancers and valuations providers.
Some networks consider second charge riskier and so won’t allow their brokers to package and submit this type of application, instead asking them to refer you to a specialist.
Enter the ‘master broker’. These firms are also made up of brokers, but they don’t necessarily interact with you the customer.
You are given advice by your broker, and then your case is passed to the master broker to submit to the lender.
However, if you find yourself referred like this, you may end up paying more than you should.
If you find yourself referred to a master broker, you may end up paying more than you should
The broker you use will receive a commission and the master broker will receive a commission, plus you’ll pay the completion fee on top. You may also pay additional fees for the advice.
This is Money has also heard rumours that some master brokers are recommending second charge deals to borrowers based on how easy it is for them to process the work, without making sure it’s the best option for the customer.
For example, recommending a lender to the customer that will accept one month’s payslip as proof of income as opposed to three months, but which charges a higher interest rate.
Some networks also have restricted referral relationships with one master broker and it is unclear whether this could be considered detrimental to borrowers.
Master broker says ‘things have changed’
Openwork is a national network with around 3,500 financial advisers operating across the UK under hundreds of different brands.
In 2015, it signed a five-year exclusive deal with master broker Enterprise Finance to package all its advisers’ second charge loans.
Harry Landy, managing director of Enterprise Finance, said: ‘The details of our commercial relationship with Openwork are clearly sensitive but I can confirm that we cap all fees on second charge loans for Openwork members at £3,000, no matter how large the balance.
‘We did charge 10 per cent fees before the Mortgage Credit Directive rules came in during 2016, as this was the norm in the market at that time. Those days are long gone. Now the fees charged to Openwork customers are nowhere near that – they’ve come down on average by around 40 per cent.’
Landy added: ‘We take treating customers fairly very seriously and put the customer’s best interests as one of our number one priorities. This is reflected in the level of detail we go into with our customers before they are recommended a loan, particularly where they are using it for debt consolidation purposes.’
Paul Shearman, director of propositions at Openwork, said: ‘At Openwork we undertake regular reviews to ensure the products available to our advisers deliver value for money for clients.
‘At the beginning of 2017 we reviewed the position on second charges and decided that even though rates were increasingly competitive, the associated fees being paid by clients were both too high and too complex.
‘We therefore took the decision alongside Enterprise Finance to cut the total fees by on average 40 per cent. We also took steps to increase the transparency of charges to ensure our clients know exactly the cost of the loan they are taking out.
‘The second charge market continues to change rapidly and we will continue to monitor developments with the aim of delivering ever better deals for clients.’
After the 2016 rules came in, some second charge brokers scrapped the 10 per cent completion fee.
Positive Lending, for example, chose to charge borrowers a flat £995 regardless of how big the mortgage balance is.
The Loans Engine scrapped its 10 per cent completion fee and started charging borrowers a flat £295 at application stage.