'Second charge' mortgages will move into the regulatory regime for mortgages rather than consumer credit when the UK enshrines the Mortgage Credit Directive (MCD) in its law on 21 March 2016.

'Second charge' mortgages will move into the regulatory regime for mortgages rather than consumer credit when the UK enshrines the Mortgage Credit Directive (MCD) in its law on 21 March 2016. HM Treasury proposes to do this by amending the definition of a 'regulated mortgage contract' in Article 61 of the Regulated Activities Order. Andrew Barber of the City law firm of Bond Dickinson takes a comprehensive look at the implications.

As well as implementing the MCD for second charge mortgages, the Financial Conduct Authority (FCA) proposes to apply some additional elements of protection from its first-charge mortgage regime to second-charge mortgages. The FCA is taking this approach as it feels constrained to remedy various poor practices in the second-charge mortgage market.

The change of regime for second-charge lenders will probably place additional costs on firms, particularly those that have not been involved in the first-charge mortgage market. It may, however, open up opportunities for firms and could, in the long run, reduce some of the operational costs.

What will change for second charge lenders?

Disclosure

The MCD introduces significant changes to disclosure requirements, particularly for pre-sale disclosure. The typical product disclosure in the second-charge mortgage market (through marketing materials and copies of contractual information) will change. Firms will need to comply with the new rules regarding the production of a European Standardised Information Sheet (ESIS). For firms that have historically not had to produce an illustration, as they must in the first-charge mortgage market, this will represent a significant change.

Post-contractual disclosure will also change. Firms familiar with the consumer credit regime will now have to update their procedures and documents to comply with Chapter 7 in the Mortgage and Home Finance: Conduct of Business sourcebook (MCOB). Arrears procedures and documents will also have to change to comply with the rules in MCOB 13. As with the pre-sale disclosure, these changes will place additional costs on firms.

Affordability assessments

The FCA, during its consultative exercise, expressed concern about poor practice in the second-charge mortgage market that involved affordability assessments, among other things. The MCD requires lenders to make a thorough assessment of a consumer's creditworthiness before lending to him. The FCA's existing regime for first-charge mortgages is very similar to the MCD requirements. The FCA is therefore going to implement the MCD through its existing affordability assessment rules in MCOB and apply these to second-charge firms.

There will be some amendments to affordability assessment rules for second-charge firms to take account of the nature of second charge lending. Rules that govern the way people consider the effect of interest-rate rises and debt consolidation are to be amended to take account of the slightly different nature of second-charge mortgages.

Although interest-only mortgages are not commonly found in the second charge mortgage market, the FCA proposes to carry across its rules on interest-only mortgages for first-charge mortgages to try to prevent risks occurring to consumers in the future.

Contract variations

Because the job of modifying consumer credit agreements is extremely onerous, contract variations in the second-charge market are not common. It is easy to vary (i.e. unilaterally change) contracts for first-charge mortgages, however, so firms can make most amendments to loans by revising illustrations and releasing them.

The FCA proposes to adopt the approach currently taken for first charge mortgage to second charge mortgages. These rules will also apply to lender's back books so are likely to represent a welcome change.

Fees

It is common practice in the second-charge mortgage market to automatically 'roll up' fees and charges. Once second-charge mortgages become subject to the rules in MCOB, it will only be permissible to roll up fees and charges into a loan for second-charge mortgages when a customer has made an active choice.

In a significant change from the current restrictions in the CCA, the FCA proposes to allow second-charge mortgage-lenders to charge early repayment charges. The rules in MCOB 12.3 (that currently apply to first-charge lenders) will apply to second-charge mortgages. It is hoped that this change will allow for the development of new loan products in the second-charge mortgage market and make it more diverse.

Excessive charges

The rules in MCOB that govern excessive charges and the charges levied on customers who are having trouble paying are going to be applied to second-charge firms. These changes could have a significant effect on some firms in the market, particularly those that make the majority of their profits through additional charges to customers.

Training and competence

The FCA has formed the view that there are similarities across the secured lending market and it is therefore important to have consistent 'training and competence' requirements no matter the type of mortgage being sold. This means that second-charge firms will have to comply with FCA training and compliance requirements but will be given a transition period until 21 September 2018 to achieve this.

What opportunities will the changes bring?

The amendment to the definition of a 'regulated mortgage contract' will allow second-charge firms to offer first-charge mortgages to customers, thus increasing their product offerings. However, this increase comes with a requirement to comply with the capital rules in the Prudential Sourcebook for Mortgage and Home Finance Firms, and Insurance Intermediaries. Firms will need to carefully weigh up the increase in business that may follow with the new capital requirements they would face.

Once the initial transition has occurred, firms are likely to find that the rules in MCOB to do with post-contractual disclosure and contract variations are easier to comply with than the current web of secondary legislation that stems from the Consumer Credit Act. This, and the consistency with the rules in MCOB for first-charge mortgages, could lead to efficiencies and cost savings in the administration of portfolios.

Ultimately, the implementation of the MCD in the UK is going to represent a further significant change for second-charge firms, especially as they have had to deal with the transfer of consumer credit regulation to the FCA. The changes are likely to involve significant transitional costs. Firms will have to think carefully about whether the opportunities that the transfer of the second charge mortgage regime are worth the extra costs they face.

* Andrew Barber is a partner at Bond Dickinson. He can be reached on +44 (0)345 415 0000.