Many borrowers have the mistaken opinion that the higher lending charge (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 one that is paid for by the borrower.
The fact that this is not made explicit to borrowers from the outset is regrettable. If it were, the borrower would realise that lender costs are being offloaded onto them – the last thing a first-time buyer, or any buyer for that matter, needs.
One has to ask the question whether this is ethical. Many lenders, including Capital Home Loans, some time ago decided that it wasn’t and have stopped the practice. Like a limited number of providers, we have genuinely HLC-free products.
Others, including some big names such as Halifax and Abbey, have not and continue to levy HLCs.
Unpleasant factors
Beyond the obvious transfer of a lender costs to the borrower, there are other less apparent factors that make the HLC particularly unpleasant. 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 the proportion of the HLC that wasn’t needed.
If the borrower actively requests a refund they will pay up, but will pocket the money if no such request is forthcoming.
Perhaps what is worse is that there are some lenders who claim to have HLC-free products up to, say, 90 per cent loan-to-value (LTV). However, once the borrower exceeds a 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 an 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 see this as lenders taking advantage of borrowers requiring a high LTV mortgage. Also that this is a practice relying heavily on the relative ignorance of most people about the ins and outs of HLCs.
The situation – surprise, surprise – is 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 which apply elsewhere to start with, so the HLC charge makes their expensive mortgage even more so.
A need for protection?
The case for the defence has some merit. Lenders that do charge HLCs argue that they have to protect themselves. They say it is something that has been done for years and is there for a purpose. With house price inflation slowing and some properties at risk of falling in value, there is arguably more need for them now than two years ago when prices were racing ahead.
They are proud of having a healthy mortgage book, and protecting it with this charge is vital at higher LTVs, they claim. If they are to offer higher LTVs to the likes of the first-time buyer, then they need to cover the risk. If they are told to stop charging, they will reduce their maximum LTVs.
You will have to judge for yourself whether this defence should be taken at face value or not. It might not bear much investigation given that the risk of default and repossession has been at a very low historical level over the past three or four years. This seems out of kilter with the large HLCs that many borrowers continue to pay.
The claim that the total cost of a mortgage varies little from HLC-charging lenders to non-HLC charging lenders has more to it. Where lenders don’t have a HLC, the cost of protection is usually reflected in the interest rate or arrangement fee. It balances out.
Treating customers fairly?
However, even supposing you accept these arguments, the practice of charging HLCs hardly fits in with the present regulatory regime and the imperative – which some have been working to for a long time – of ‘Treating Customers Fairly’.
It’s obviously the case that it would be more transparent to get rid of the charge and allow lenders to compete on a level playing field.
There can’t be many who would be brave enough to claim that the charge is transparent, because it patently is not. An interesting question here would be what proportion of borrowers understand exactly what they are paying for with their HLC.
My suspicion is not many. Any non-transparent charge is in danger of flying in the face of ‘Treating Customers Fairly’. It is clearly perverse for lenders to woo customers with free valuation and cashback deals, and then hit them with this charge.
The very existence of a HLC means the cost to the borrower is significantly higher than the advertised rate of interest would suggest. Borrowers, often those going direct, are drawn in by an attractive headline rate and only spot the HLC later on. A number of lenders are particularly adept at successfully combining low interest rates with higher lending charges – scarcely transparent.
Such smoke-and-mirror antics can also mean extra work for the intermediary who has to make up for the complexity of the charges by spending longer with the customer, explaining the hidden catch of this charge and calculating the equivalent rate of interest if he excluded it.
For lenders that want to keep their pricing structure as clear as possible, HLCs do not fit in with the present customer-centred regime.
Writing on the wall
Putting all this to one side though, the writing seems to be on the wall for the HLC. You only have to look at its gradual decline in recent years.
Fewer lenders are charging it and intermediaries are instinctively suspicious of products that feature it. How can they in conscience advise a client to take out an HLC-charging mortgage when such a charge is levied to benefit the lender? And the costs are often rolled up over a decade or two.
If a lender were to demonstrate that, through the addition of a HLC, they could offer clients sufficient savings on the interest rate and other costs to more than make up for the charge, intermediaries might be happy. Usually lenders cannot though, and instead rely on clients to let them get away with HLCs effectively hidden through the magic words ‘added to the loan’.
The heightened customer focus that brokers now have, thanks in part to FSA regulation, makes this increasingly difficult to justify. So, no matter how tightly some lenders may cling to the practice, it will not be long before it passes into history. HLC, RIP.
Bob Young is managing director of Capital Home Loans
