Responsible Lending and Affordability
After the financial crisis the FCA rebuilt the rules so that lenders, not borrowers, are responsible for lending affordably. This topic covers the Mortgage Market Review, the affordability and income-verification rules in MCOB 11, the interest-rate stress test, the strict conditions on interest-only lending, the effects of the Mortgage Credit Directive, and the meaning of the APRC.
The Mortgage Market Review: the lender is responsible
The Mortgage Market Review (MMR), in force from April 2014, made a fundamental change: the lender is responsible for assessing whether a mortgage is affordable, and it must not rely on the borrower's self-assessment. This effectively ended self-certification ('self-cert') mortgages, where borrowers stated their income without evidence. Under the MMR a lender must verify income with acceptable evidence rather than take it on trust, and must assess affordability properly before lending. The principle behind the whole responsible-lending regime is that a mortgage should only be granted where the customer can demonstrably afford it, both now and, so far as can reasonably be foreseen, in the future — protecting borrowers from taking on debt they cannot sustain and protecting the wider system from reckless lending.
Verifying income and assessing expenditure (MCOB 11.6)
The core rule in MCOB 11.6 is that a lender must not enter into a regulated mortgage contract unless it can demonstrate that the mortgage is affordable for the customer. To do this the lender assesses income against expenditure. Income must be verified with evidence appropriate to the customer: for an employee, typically payslips and bank statements (and sometimes an employer's reference); for a self-employed applicant, usually accounts and/or the HMRC tax calculation and tax-year overview (SA302s), commonly for the last two or three years. On the expenditure side the assessment must take account of the customer's committed expenditure (existing credit commitments and other contractual outgoings such as loans, credit cards and maintenance), basic essential expenditure (unavoidable costs of living such as food, utilities, council tax, insurance and basic travel), and basic quality-of-living costs (non-essential but reasonable and hard-to-reduce spending). The lender does not simply take the customer's word for these; it uses evidence and realistic estimates, often benchmarked to statistical data. Where it is known that income or expenditure will change materially during the term — for example the mortgage extends into retirement, when earned income falls and pension income applies — the lender must assess affordability against the expected future position, not just today's.
The interest-rate stress test
Because most residential mortgages are variable at some point, MCOB 11.6 requires the lender to apply an interest-rate stress test: it must consider whether the customer could still afford the repayments if interest rates were to rise during the early years of the mortgage. The rule requires the lender to have regard to likely future rate movements over a minimum period (a minimum of five years from expected completion), taking account of market expectations and any relevant recommendations of the Bank of England's Financial Policy Committee, and to assume a minimum increase in the interest rate. The point tested in CeMAP is the concept: affordability must hold not only at today's pay rate but under a plausibly higher rate, so a borrower who could only just afford today's rate would fail. The stress test does not generally need to be applied where the rate is fixed for five years or more (or for the whole term), because during that period the payment is not exposed to rate rises. YMYL: the precise stress assumptions have been refined by the FCA over time, so verify the current MCOB 11.6 requirement rather than relying on a fixed percentage.
Interest-only lending under the responsible-lending rules
Interest-only mortgages are permitted, but only on strict conditions, because the capital is not being repaid month by month. Under MCOB the lender may grant an interest-only mortgage only where there is a clearly understood and credible strategy to repay the capital — for example a repayment vehicle such as investments, a pension lump sum or the sale of another asset — and the lender must obtain evidence of that strategy and check its plausibility, not merely accept a vague intention. Reliance on future house-price growth is not an acceptable repayment strategy. For affordability the lender must not assess an interest-only loan as if the low interest-only payment were the whole story where that would understate the true cost of ownership; the rules require the repayment strategy and the customer's ability to fund it to be taken into account. The result is that interest-only lending today is far more constrained than before the MMR and is often confined to borrowers with substantial assets or clear repayment plans.
The Mortgage Credit Directive and its effects
The Mortgage Credit Directive (MCD), implemented in the UK in March 2016, extended and standardised mortgage regulation. Its main effects for CeMAP are: it brought second-charge (secured) mortgages fully within MCOB, so they are now regulated alongside first charges; it created the 'consumer buy-to-let' (CBTL) regime for borrowers who are not acting wholly for business purposes (for example an accidental landlord), giving them protection that ordinary business buy-to-let does not have; it introduced the ESIS as the standard pre-contract disclosure (replacing the KFI); it introduced the binding-offer reflection period; and it introduced the APRC as a standardised cost measure. Understanding that the MCD widened the perimeter (second charges and consumer BTL) and standardised disclosure is a common exam theme.
The APRC: comparing the true cost
The Annual Percentage Rate of Charge (APRC) shown on the ESIS expresses the total cost of the mortgage to the consumer as a single yearly percentage of the amount borrowed. Unlike the headline interest rate, the APRC is designed to reflect the overall cost over the life of the mortgage — it takes account of the initial rate, the rate the loan reverts to (for example the SVR after a fixed period), and mandatory costs such as certain fees, assuming the loan runs for its full term. This makes the APRC a tool for comparing the long-term cost of products with different initial rates, fees and reversion rates: a low headline rate with high fees and a high revert rate may carry a higher APRC than a slightly higher headline rate with a better reversion. Advisers should explain that the APRC is a comparison aid based on assumptions (notably that the customer keeps the mortgage for the full term and rates behave as assumed), and that in practice many borrowers remortgage before reverting — but for the Consumer Duty's fair-value assessment it is a useful whole-of-life cost signal.
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