When is an industry standard not an industry standard? When it’s an APR.
While the industry continues to squabble over the relevance of APRs, there is one thing most brokers and lenders can agree on – no two APRs are ever the same.
The use of APR, or annual percentage rates, has come under increasing scrutiny as more disgruntled industry opinion makers urge the financial services industry to dump what they claim is a mis-leading and outdated method of letting mortgage borrowers know what they’re paying.
Outdated and unrealistic
Simon Whittaker, finance director at Mortgages for Business, said he was pushing the City watchdog to abandon APRs for a ‘saner’ system, while Jonathan Cornell, technical director for Hamptons International Mortgages, branded APRs ‘the great white elephant of the mortgage market’.
He says: “APRs are a pointless indicator, based on the highly unrealistic scenario of a client finishing their rate and being too
stupid or too lazy to switch products for a better rate, even with their existing lender.”
Cornell claims the decision by several big lenders including Halifax, Nationwide, Woolwich and Northern Rock to allow existing borrowers the ability to switch to a new rate further emphasises the irrelevance of APRs.
He says: “The APR is calculated assuming the customer is spending so many years on a standard variable rate (SVR). The fact is borrowers are getting more savvy and lenders are offering more incentives, therefore people are not spending so long on the SVR”
But lender incentives or not, the fact is the City watchdog’s hands are tied when it comes to APR. After all, as Cornell points out, it’s not up to the Financial Services Authority (FSA) whether or not it enforces the use of APRs.
But while the FSA is in fact tied by a European directive dating back to 1987, the use of APRs dates back even further; it’s been used to guide consumers through the mortgage-borrowing maze since 1974, when it was introduced as part of the Consumer Credit Act (CCA).
The CCA aims to ensure that borrowers are able to compare one loan with another.
In theory, all APRs should average the cost of interest payments, additional charges, such as administration or acceptance fees, survey fee, broker’s fees and payment protection insurance (PPI) or maintenance charges.
But the fact is, over 30 years after they were introduced, APRs are the industry standard that never was.
In fact, one of the country’s most respected financial research companies, Moneyfacts, totally ignores the APR given to it by mortgage lenders.
Darren Cook, Moneyfacts mortgage researcher said: “Each lender calculates its APRs completely differently.”
“It can differ tremendously from lender to lender depending what they include. Some included everything, survey fees, exit fees, and legal fees and the valuation. While others will only include exit or arrangement fees and the interest rate.”
Cook says for this reason, Moneyfacts chooses to calculate its own APRs.
He says: “There is no concrete standard used by the industry to calculate APR, but lenders are obliged to explain their calculations to consumers when quoted in advertisements or any form that constitutes an invitation to purchase their mortgage products.”
If Moneyfacts used the APRs given to it by the lenders themselves, Cook claims, consumers using its best-buys service would end up ‘comparing apples to oranges’.
Moneyfacts has instead chosen to use a standard calculation that allows it to provide consumers with consistency throughout the 126 providers and over 8,500 financial services and products it features.
Calculating it fairly
Cook says Moneyfacts calculates the APR using four main pieces of information from the lender. This includes arrangement fees, which may include booking fee, or any other names a lender may call them.
It also includes any valuation fees and valuation admin fee; legal fees and where cashback is deducted.
Cook adds: “For example, if a mortgage lender is offering free legals or £250 cashback, then the cashback will take precedent over the free legals, as above, as the cashback is a known quantity,” explains Cook.
The fact that Moneyfacts even uses an APR of sorts is proof that the industry is committed to the concept of giving consumers the ability to compare mortgages
Like many in the industry, Linda Will, managing director at Accord Mortgages, agrees with the idea of APRs. She says: “On the whole they take into account everything the customer should know and protect them from overpaying on a loan that is likely to be the biggest expense of their life anyway.”
Will believes APRs should be replaced with a more easy to understand flat fee calculation that gives every borrower an idea of what they should be paying.
“For example, every mortgage lender could use a ball mark borrowing amount, say £100,000, and then tell borrowers that if they take out their two-year fixed rate deal, they could expect to pay a total of £200,000 by the time the 25-year mortgage term is over.
It would give borrowers something tangible, on which they could physically see how much they will spend.”
Will claims such information, provided clearly and upfront, would alert borrowers
“Customers interpret things differently and this way it would be completely unambigious,” she says.
Expecting too much?
But is the industry expecting too much out of APRs? Joe Wiggins at Abbey believes so. He claims expectations of APRs are too high.
He says: “APRs are intended as a guide, they are becoming more and more irrelevant because when most borrowers want to know how much they are going to pay they can look at the Key Facts Illustration (KFI) provided instead.”
Abbey believes statutory mortgage regulation is helping revolutionise consumers’ understanding of mortgage products.
Wiggins continues: “Realistically, most people don’t keep their mortgage going for its full term anyway. The APR is an average rate that calculates what a borrower can expect to pay if they have the same mortgage for life.
“We are seeing so many more savvy borrowers who are moving their mortgages just a couple of years after taking them out.”
It isn’t just peripatetic consumers who are making APRs irrelevant says Wiggins. “We are noticing that more people are paying attention to the headline rate (i.e. the actual interest rate).”
This, he adds, is because consumers are zoning in to the fact that APRs do differ between lenders. “The headline interest rate says how much interest they will actually pay and for many that is what they want to know.”
Louise Cumming, head of mortgages at moneysupermarket.com agrees.
She says APRs are not effective because they measure the annual rate calculated over the full term of the mortgage, so if you take out a 25-year mortgage it will be calculated over the 25-year term.
She says: “In reality, borrowers are extremely unlikely to keep the same mortgage with the same lender on the same conditions for the original term; therefore, the APR becomes unrealistic. With more lenders eager to retain customers, they are agreeing to restructure mortgages onto a different product. Because of this continual switching between deals, it will become even more unlikely borrowers will revert onto SVR. This is yet another reason why the APR isn’t the best way for potential borrowers to compare mortgages.”
But Jill Usher, principal at Hunter Mortgages in Livingstone, believes the lenders have got it wrong.
She says: “I don’t believe customers are that savvy to be honest. And we, as an industry, have a role in educating them.”
Usher says the APR is the best and closest thing the mortgage industry has to a benchmark.
“I do use it, but I wouldn’t say that I trust it. When I do a search for a client, I will always look at the mortgage with the lowest APR because I know that by its nature it will be a cheaper mortgage.”
But like many advisers, Usher is still in a quandary when it comes to using the APR as a guide
“Because no two APRS are the same you really do rely on your own product knowledge. For example, you will know, just through being an experienced broker what is a good deal and what isn’t.”
The bottom line is that customers don’t understand APRs, claims Usher.
“I don’t think a lot of brokers even understand what they mean.”
Consumer awareness
Lack of consumer awareness is something Yorkshire Building Society is also concerned about.
Tanya Jackson, media relations manager at Yorkshire Building Society, admitted some lenders could use APRs to disguise hidden extras, for example, the fact they may calculate interest on an annual and not daily basis.
“An APR won’t tell you everything,” she explains.
“We would also warn borrowers to be careful when comparing APRs, as they have been calculated based on the full term of the loan and may be deceptive if the borrower plans to remortgage or overpay during the term. As virtually all borrowers take a special rate deal, a true cost figure, which includes all fees and cashbacks over the term of the special rate period, may be a more useful figure for comparison purposes.”
So what’s the solution? Alex Hammond, PR manager at Kensington Mortgages, says if the regulator is tied by the use of APRs then there should be more room made within the KFI.
Kensington would like to see the FSA introduce a separate box on a KFI to indicate the cost of a deal if some was to remortgage at the end of a preferential term.
Hammond says: “It could give clients a breakdown of how much they will pay if they keep the mortgage loan going for two years, which is a more realistic figure to give than if they kept the same mortgage for 25 years.”
“A proper breakdown would allow borrowers to shop around, especially because lenders have such diverse ways of presenting their APRs.
“It would also improve transparency, as the true cost of things such as higher lending charges (HLCs) would be flagged up more clearly than with an APR that typically calculates the effect over a 25-year period.”
But it is Wills’ idea of giving customers a median figure that meets with most approval from intermediaries like Usher.
“Having something they can see is great. It’s also in the interests of ‘Treating Customers Fairly’ that people really understand what they are borrowing.”
Will adds: “We shouldn’t be using benchmarks that people don’t understand. Getting rid of APR assumes customers are savvy, but many are not.”
