Lending charges are currently one of the most contentious issues in the mortgage industry.
Scarcely a week goes by without them making headline news in the mortgage press. Exit fees, higher lending charges (HLCs), arrangement fees, completion fees and general administration charges have all been the subject of heated media debate.
Earlier in the Summer, the Financial Services Authority (FSA) announced that it had fees firmly in its sights, warning mortgage lenders about what it believed were unfair exit administration fees.
Speaking at the Council of Mortgage Lenders (CML) annual conference, chairman of the FSA, Sir Callum McCarthy, said the regulator had reviewed a range of mortgage contracts and wanted lenders to remember that when they change their charges, the ‘Unfair Terms in Consumer Contracts Regulations’ required fairness.
He also cautioned that the FSA would be looking into early repayment charges (ERCs), which he said were the subject of most consumer complaints. Although the FSA had not found widespread malpractice in the mainstream lending market, he said, it was concerned that there were different practices in place within non-conforming and there may be firms including ‘inappropriate costs in their calculation of ERCs’.
A necessary evil?
Despite these legitimate concerns of the FSA, it has to be admitted that fees and charges in general are, at present, a necessary part of the mortgage market.
The intense level of competitiveness that exists in the UK market has resulted in the widespread availability of heavily discounted mortgages.
Borrowers have come to expect very attractive headline interest rates and lenders have obliged, providing UK consumers the lowest-margin products anywhere in Europe.
Intermediaries can point to any number of products that are currently on the market that are initially available at or, sometimes, even below cost price.
The lenders making available such bargains have to make a return on investment at the end of the day and one of the mechanisms used to ensure that they are more likely to do this is fee charging.
In the case of discounted products that offer an attractive headline interest rate, the ERC is key. If a lender cannot retain a customer beyond a minimum period, then the product becomes a loss maker. Do away with the ERC and out will go big discounts.
That said, the level of ERCs does vary considerably from lender to lender and can be particularly high in the non-conforming sector. This is not so easily defensible, especially when consideration is given to the charges at the upper end of the spectrum.
Such high charges do nothing to enhance the reputation of the industry and can leave the consumer with a distinctly bad taste in their mouth.
Aside from ERCs, the HLC is another cost that is the subject of heated debate.
According to a report from the Nationwide Building Society, HLCs will account for £2bn of consumer costs in 2006.
Again the reason for the charge is pretty obvious – lending at higher loan-to-values (LTVs) is riskier than lending at lower LTVs. If the client wants to borrow more, the lender wants to cover some of that risk in the form of a HLC. Get rid of HLCs and lenders will seek other ways of compensating themselves for that risk in the form of much higher initial rates or will stick to lower LTVs.
That said, there is quite a bit of misconception about the HLC.
HLC worry
Many borrowers have the mistaken opinion that the HLC is their insurance policy and safeguards them against their property dropping in value. As we all know, it is no such thing, and only indemnifies the lender. It is a policy that benefits the lender, but which is paid for by the borrower.
The fact that this is not always made explicit to borrowers from the outset is regrettable. If it were, the borrower would realise that a lender cost is being offloaded onto them.
Beyond the obvious transfer of a lender cost to the borrower, there are other less apparent factors that make the HLC not particularly pleasant. For example, it is often the case that when borrowers redeem their mortgage after a year or two, lenders do not as a matter of course refund to the borrower that proportion of the HLC that was not needed.
If the borrower actively requests a refund, the mortgage lender will pay up, but will pocket the money if there is no such request.
Perhaps what is worse is that there are some lenders who claim to have HLC-free products up to say 90 per cent LTV. However, once the borrower exceeds the 90 per cent LTV threshold, the lender charges an HLC premium from a trigger point of 75 per cent.
This is a deceptive practice because borrowers are often unaware that if they were to marginally decrease their loan size under this 90 per cent threshold, say to 89 per cent, they would completely escape a HLC charge of thousands of pounds.
If lenders are happy to lend 90 per cent HLC-free, why, if a borrower goes to 95 per cent, do they not charge for HLC protection on the 5 per cent difference between 90 per cent and 95 per cent? Instead, they go back down to 75 per cent.
There is a danger that some might view this as lenders taking advantage of those borrowers requiring a high LTV mortgage loan. Also, this is a practice that relies on the relative ignorance of most people about the in’s and out’s of HLCs.
The situation is perceived to be at its worst within the non-conforming sector. Lenders here seem to be very accomplished at HLC charging, so borrowers who often can least afford it have to unwittingly pay the highest HLCs. They have to put up with higher interest rates than those who apply elsewhere to start with, so the HLC charge makes their expensive mortgage even more costly.
Stealth fees
Alongside ERCs and HLCs, tariff of mortgage charges have to be a concern for any advocate of the FSA’s ‘Treating Customers Fairly’ (TCF) approach.
Many commentators have labeled lenders’ tariff of mortgage charges as ‘stealth’ fees. They concern the charges levied for a whole range of post-completion services, from sending out a reminder letter for a missed direct debit, to converting to interest only, duplicate documentation and redemption administration.
They are not featured in the APR and vary massively from lender to lender. Mortgage lenders are required by MCOB rules to disclose most of their fees in a certain format within promotions and of course on KFIs, but not fees within the tariff of mortgage charges.
In addition, while one lender might charge, for example, £10 for a missed direct debit payment, another may well charge £75.
Given that a mortgage term can run to 25 years, it is easy to see that if a lender is charging excessive ‘back-end’ fees, the costs to the borrower will be considerable over time.
Miss a few direct debits at £75 a go and the APR quoted on the product will be pretty useless at reflecting the total cost of the mortgage.
If there was anywhere within the mortgage charges arena that would benefit from standardisation and the influence of the FSA, then this is it.
More mortgage lenders are expected to fix their exit fees following an FSA review of the charges, to be published in the Autumn.
The high stealth tariff charges used by some lenders look suspiciously like profiteering. How can they sensibly justify charging excessive amounts for what are straightforward administrative tasks?
APR failings
The problem with these charges, as mentioned, is that they are not contained within the APR, meaning that it often fails to represent the true cost of the mortgage in today’s environment, where most borrowers remortgage at the end of a deal.
It would be sensible for a box to be added to KFIs showing the true cost of a mortgage at the end of the deal, showing a variety of mortgage costs at both application stage and during the lifetime of the mortgage.
Apparently, the FSA has its hands tied by a European directive which means it cannot replace the APR completely, but an additional ‘true cost’ reference on the KFI can only be a good idea.
While the industry can easily justify the existence of its fees and charges when they are transparent and represented fully in cost illustrations, it is a far more tricky job to stand up for them when they are conveniently given limited attention in consumer documentation.
