As the debate over the effectiveness of APRs in the mortgage market gathers pace, the government and the Financial Services Authority (FSA) have given their tacit support to retaining the current system, via a response to the European Union’s (EU) Questionnaire on Mortgage Credit.
The questionnaire, part of the EU’s ongoing work into the harmonisation of the European financial services sector, asks whether mortgages should have a specific APR mechanism, separate to the APR used by other credit agreements. In a joint reply, the Treasury and the FSA indicate that existing EU legislation relating to APRs should be used.
Nowhere in the reply to the EU does the Treasury or the FSA refer to the questions currently being asked about the suitability of APRs for comparing mortgages. Neither does the response mention calls by lenders and brokers for changes to the APR system and the introduction of alternative methods.
Ignoring the issues?
Broker Danny Lovey, who operates as The Mortgage Practitioner, has long campaigned for changes to the APR system. In a letter to Mortgage Introducer, Lovey reacted angrily to the response from the Treasury and the FSA, questioning whether its author had any knowledge of the mortgage industry at all.
Lovey wrote: “In view of all the rantings from us over the last year or so, you would have thought the government and the FSA would have at least acknowledged that the issue was contentious in (its) response.”
He continued: “Who wrote it? Have they any knowledge of the market at all? What planet or ivory tower do they live in? It would appear all we have said over recent years and months has been completely ignored, or the person who wrote it has not performed any kind of consultation with the industry.”
The financial regulator acknowledges the debate within the mortgage industry about the current APR system, but points out that as it is based on EU legislation, the UK is forced to use it along with all other member countries.
Robin Gordon-Walker, FSA spokesman, explains: “The 1987 EU Consumer Credit Directive requires the UK to use the APR, as well as setting out what goes into the formulation. The FSA’s MCOB rules on APRs for mortgages are derived from that directive.”
Gordon-Walker also points out that the UK mortgage industry is one of the few in Europe that is actually regulated. This means any tightening up of EU legislation on APRs would actually be likely to improve rules across the rest of the continent, bringing other countries in line with the UK.
In fact the EU’s Questionnaire on Mortgage Credit seems to be asking whether a separate APR is needed as part of proposals by an EU Green Paper for changes to the existing Consumer Credit Directive.
The questionnaire asks EU member governments to ‘assess the merits of having a specific mortgage APR and in particular consider whether the APR proposed in the Consumer Credit Directive should also apply for mortgage credit.’
In response, the Treasury and the FSA said: “Existing EU legislation already provides a standard basis for the APR calculation. This should be as similar as possible for consumer credit and mortgages, subject to the views expressed on the detail of the calculation. This approach has two advantages:
consumers are provided with a yardstick by which to compare secured and unsecured credit meeting the same purpose; and
the costs are minimised for businesses active in both markets.’
The questionnaire then asks what costs should be included and excluded in the APR. Again the UK’s response refers to the existing directive on which the current APR is based, stating that the APR should ‘capture all the unavoidable costs relating to the credit transaction’.
Less regulation?
The UK’s response to the entire EU questionnaire is a call for European harmonisation to bring about a more level playing field, and therefore greater access to other continental markets for UK providers. To achieve this, the Treasury and the FSA are actually calling for less regulation.
The UK response says: ‘In our view, the Commission’s priority should be areas where enhanced market access may be achieved through non-regulatory initiatives.
‘In this light, the Commission should focus on improving the efficiency of mortgage funding arrangements across the EU. This has the potential to deliver benefits to consumers, through lower prices and product innovation, and to help reduce barriers to market entry for mortgage lenders.”
In this sense it could be claimed that by not rocking the boat on the subject of APRs, the Treasury and the FSA are actually trying to prevent more regulation being forced on the UK mortgage industry by Europe.
To underline this point, the response also says: ‘It should be understood that, in our view, harmonising consumer protection across member states should not be a focus of the Commission’s work. We do not believe this is likely to promote the further integration of EU mortgage markets. Moreover, the UK’s recent experience of introducing mortgage regulation is that creating or changing advice and information disclosure regimes can result in very significant costs. The emphasis should therefore be on respecting existing national arrangements for consumer protection.’
As such, in addition to better regulation, the UK response calls on the EU to focus on alternatives to regulation and better enforcement to help create and deliver a more competitive and harmonised mortgage industry across Europe.
In terms of the existing APR system, the FSA also admits it should not be relied upon solely when comparing mortgages. On its consumer-facing website the FSA states: ‘You should also be aware the APR for a mortgage does not always tell you the whole story. The APR is a useful tool for comparing the cost of mortgages. However, as with other loans, you should consider the whole mortgage and its features before making a decision whether it is right for you.”
Adding fuel to the fire
But even this advice adds more fuel to those within the industry that believe the APR is a waste of time when applied to mortgages. Commentators as diverse as lender Abbey, brokerage, Hamptons International Mortgages, financial research body, Moneyfacts and consumer finance website, Moneysupermarket.com, have all stated their belief that the current APR mechanism is flawed.
Their argument is that APRs are designed to show the cost for a mortgage over a longer period, of 25 years, for example. This means they are less relevant in the modern marketplace, where many customers switch home loans every three years or so. Other critics point to the fact that APRs do not include costs such as higher lending charges (HLCs) or exit fees, so they don’t show the true cost of a mortgage over the length of the deal. They claim that this means consumers who compare APRs are not getting a true comparison of the best mortgage deals on offer.
Specialist lender Kensington Mortgages, says the real issue for borrowers is about transparency on charges where there is currently poor consumer understanding, sighting the main culprit for this as the high lending charge (HLC).
Alex Hammond, PR manager at Kensington, says: “We have raised the issue of HLCs in the past, but there still seems to be confusion about the true impact of the charge. It is peculiar to the UK market that most borrowers do not keep their mortgages for 25 years, but keep them for a short-term, switching deals every two or three years. In the interests of ‘Treating Customers Fairly’, consumers should be able to compare deals on that basis.”
However, Hammond says many borrowers, packagers and brokers will still look at the monthly payments on a mortgage when comparing deals, without taking into account any charges that are incurred at the backend of the deal. He continues: “We feel that a field on the Key Facts Illustration (KFI), stating how much a borrower will owe at the end of the early repayment charge tie-in period, would help to solve the problem of transparency regarding HLCs. In the current market, many borrowers remortgage at the end of the tie-in period and the HLC added to the loan is often not paid off by the time they remortgage – leaving borrowers owing more than when they started.”
Hammond says he appreciates that a change to the KFI would be difficult, but adds that banishing of the HLC would ultimately remove this confusion.
He says: “The debate over transparency on HLCs has been bubbling for some time and occasionally reaches the surface. But now the debate has been raised, we have the opportunity to ensure that it doesn’t fade away.”
“There needs to be more information in the KFI to indicate the true cost of the mortgage. This formula should take into account extra charges, such as HLCs and exit fees. This would enable consumers to see how those extra charges impact on their finances.”
Hammond says the trend for short-term mortgage deals means that often consumers are fixated on the headline rate, even though products with higher interest rates but fewer extra fees may actually be more cost-effective. He explains: “People may not realise a lower APR does not mean a mortgage is cheaper. By providing this extra information on the KFI document, borrowers would be able to shop around with more transparency.”
