Mortgage Credit Directive Explained
The Mortgage Credit Directive is a legal framework that was put together by the EU to conduct rules for any individual, firm or introducer offering first charges, second charge consumer buy to let mortgages on residential property in the UK. The new legislation was implemented by the Financial Conduct Authority on 21st March 2016.
The new regulation treats first and second charge mortgages equally – so whilst second charge loans used to fall under consumer credit, now any businesses, lenders or brokers offering this service must be authorised and hold the correct permissions for mortgages. For second charge customers, it means that they must now go through the more thorough checks associated with getting a mortgage, rather than a standard loan.
The MCD applies to credit agreements that are secured by a residential mortgage and to credit agreements used to acquire or retain property rights in land or in an existing or projected building. The rules are applicable to the following stakeholders involved in mortgages and bridge finance:
- Appointed sales representatives
The directive was set up by the EU as part of the G20 commitment to improve the conditions and underwriting of credit agreements relating to immovable residential property (Source: Wikipedia). The decision was aimed to safeguard and prevent irresponsible lending and borrowing in the mortgage markets that caused havoc in the US during the housing crisis of 2006 to 2008, perfectly portrayed in the film “The Big Short.”
The Mortgage Credit Directive sets out some common rules for mortgage lenders and brokers to follow. In doing so, this should create a residential market that better informs customers about the real costs of a mortgage and allow them to compare effectively between competitors. There is a key aspect to reflect on the mortgage contract before going ahead and this is aimed to protect mortgage applications from unfair and misleading practices by firms.
The following are adapted from The Government’s Guide of EU Mortgage Credit Directive.
European Standardised Information Sheet (ESIS)
Before the mortgage contract is completed, applicants will be provided with a European Standardised Information Sheet (ESIS). This is similar to the pre-contractual information that is given to most mortgage applicants across Europe but the ESIS is more detailed.
It includes a seven-day reflection period for the borrower to decide whether or not they want the loan and the EU member state can decide whether to administer this in the pre-sale or post-sale period.
The document includes the impact of interest rates including the Annual Percentage Rate of Charge (APRC) and offers example monthly payments in case they rise to the highest level in the past 20 years. This is a way of saying that ‘this is the highest you could pay’ in extreme circumstances.
The ESIS must be given in good time before the closing of the credit agreement allowing the customer to compare other rates and ask for third party advice.
Annual Percentage Rate of Charge (APRC)
Part of the ruling of the directive means that customers are presented with the Annual Percentage Rate of Charge (APRC) and this should allow borrowers to do the following:
- See the whole cost of the mortgage and all fees
- How much the mortgage would cost if you kept it for the full loan term i.e 5 years, 10 years 25 years etc
- Compare effectively against other similar mortgage products.
Example of APRC: Imagine you want to borrow £500,000 with a 25-year mortgage. Halifax charges 1.14% on a two-year fixed rate deal but once the two year period ends, you will be subject to paying the standard variable rate of 4.99%. Therefore as part of the new regulations, the APRC shows you the full cost for the entire loan term as though it were 25 years, giving you an interest rate of 4.6%.
So ultimately the APRC shows you what you would be paying if you stayed with the same mortgage agreement for the entire loan period. However, this is unlikely as people realise that they can save massively by remortgaging at the end of the introductory period. So it is important for applicants and borrowers to look at the introductory rate first, which in this case is 1.14%.
Mortgage lenders are now required to make a binding offer when providing a mortgage contract. A binding offer is when a mortgage provider draws up a contract stating the terms of the agreement and willingness to lend. It is part of a legal contract but does not become officially legally binding in a court of law unless the borrower accepts and signs the contract. It is common for binding offers to remain open some time to allow the borrower to make a decision and also consider other alternatives.
7 day Reflection period
Customers now have a 7-day reflection period where they can think and decide if the mortgage agreement is right for them. During this time, they can also investigate and compare other deals available. Since this was introduced by the EU, all member states can decide whether they introduce the 7-day period pre-sale or post-sale of the mortgage agreement, or even a combination of the two.
Tying and Bundling
The Directive has strict rules on lenders that want to ‘tie’ or ‘bundle’ additional products or services with the credit agreement. This has usually been offered by lenders to diversify and compete with other companies but can also lead to less mobility for customers and the feeling of being tied down. Therefore, the new rulings aim to limit bundling that can have a negative impact on the borrower but also keep anything which may be beneficial.
Whilst most lenders and brokers already encouraged property valuations prior to forming credit agreements, it is now a requirement to have a valuation that is internationally recognised by the likes of the International Valuation Standards Committee and the Royal Institution of Chartered Surveyors.
There are now measures in place to protect those that are applying for loans in a foreign currency. Since exchange rates can fluctuate massively over a mortgage term that lasts several years, there is now an effort to safeguard borrowers from exchange rate risks.
Assessing a Customer’s Creditworthiness
Additional guidance has been issued for lenders to assess a customer’s credit prior to engaging in a mortgage contract. This can be through the use of credit checking via a credit reference agency such as Experian, Equifax or CallCredit.
The customers’ ability to refinance the credit agreement should be assessed and verified before the conclusion of the credit agreement. The assessment should also reflect on other factors that may inhibit their repayment of a loan such as number of dependents, income, debt to loan ratio and other commitments. Lenders and brokers must look beyond the fact that investing and purchasing a property can generate more income and value and this should not be an excuse for giving credit.
Allow Early Repayment
Whilst already common with most mortgage lenders and providers, customers must now always be given the option to repay their loan early, before the credit agreement ends. In fact, the ability to clear their debts early can play quite a big role when comparing the different rates and cost of a loan. The Mortgage Credit Directive believes that the option to repay early promotes healthy competition in the industry and financial stability within the sector.
The MCD includes new rules if you suddenly become an accidental landlord such as inheriting a property or needing to let out your primarily residence.
This is the first time ever that accidental landlords will be regulated by the Financial Conduct Authority which implies much stricter income and affordability assessments than previously, as though you were applying for a typical mortgage.
The MCD has also brought in new rules if you’re an ‘accidental’ landlord, for example if you’ve inherited a property, or if you plan to let out a property that you have previously lived in as your main home.
However, if you are professional landlord with a limited company and own more than one buy-to-let property, you will continue to fall outside the scope of the FCA. So if you are an accidental landlord, this may be an option to take to limit your compliancy needs.
What About Commercial Property?
The MCD totally excludes commercial property that is used for purchase or buy-to-let. This includes office blocks, shops on the high street, gyms, schools and more.
The new legislation also excludes properties that are ‘mixed use’ provided that the property is used more for commercial than residential reasons. An example of this is an office building with a flat above it.
The directive also excludes any contract for the purposes of a person’s business, trade or professional, assuming that the borrower is not acting as the consumer.