Fancying a smoke, a drink or three, a weekend shop, a chockie or two, or a night at the cinema could rule you out of getting a mortgage under tough new proposed rules in Britain from the country’s financial regulator, the FSA.

The proposed new rules would also ban what’s called “self certification” mortgages (they would be no doc or low doc loans here). Re-mortgaging a home (or refinancing an existing mortgage, would also become tougher). Lenders would become virtually responsible for their borrowers.

The whole idea seems to be de-risk home lending to the absolute minimum by a key regulator still coming to terms with its failures during the huge housing boom. It failed to regulate non-bank lenders, failed to spot the problems of banks borrowing short term in wholesale markets and lending long term on mortgages, and most crucially, it failed to spot or stop abuse by borrowers and lenders.

Perhaps the crowning failure of the FSA was the collapse of the fast growing home lender, Northern Rock (which at one stage was offering a mortgage worth 125% of the value of the property to be mortgaged).

The contrast with the attitude of Australian regulators is quite telling: APRA here told banks to allocate more capital against low doc or no doc loans: that’s why the overwhelming majority of failed or failing home loans in this country are in non-bank lenders. There are around 25,000 mortgages on the banks’ books that are in arrears or worse. In the UK, its in the hundreds of thousands.

The highlights of the changes include, according to the FSA:

  • Imposing affordability tests for all mortgages and making lenders ultimately responsible for assessing a consumer’s ability to pay;
  • Banning ‘self-cert’ mortgages through required verification of borrowers’ income;
  • Banning the sale of products which contain certain ‘toxic combinations’ of characteristics that put borrowers at risk;
  • Banning arrears charges when a borrower is already repaying and ensuring firms do not profit from people in arrears;
  • Requiring all mortgage advisers to be personally accountable to the FSA;
  • Calling for the FSA’s scope to cover buy-to-let and all lending secured on a home.

“The FSA needs to ensure that firms only lend to people who can afford to pay the money back. The reforms that we have announced today will ensure that the mortgage market works better for consumers and that it is sustainable for firms.”

The upshot of the affordability tests would see borrowers financial viability and spending assessed.

In a note to the media, the FSA said “Affordability tests: the DP (Discussion Paper) proposes making the lender ultimately responsible in every sale for verifying affordability. It also proposes that in each case a lender should assess the consumer’s ability to repay, i.e. calculate the free disposable income a consumer has to pay for the mortgage.”

“A mortgage is affordable if its level and terms allow the consumer to meet current and future payment obligations in full, without recourse to further debt relief or rescheduling, avoiding accumulation of arrears, while allowing an acceptable level of consumption. We believe therefore that a lending decision should be based on the size of consumers’ free disposable income (i.e. income net of all expenditure).”

An illustrative table in the discussion paper lists what the FA believes is the sort of spending which would reduce “consumers free disposable income” and therefore the amount people could borrow under a new or refinancing mortgage.

That includes the following: “Food and drinks, Alcohol and tobacco, Clothing and footwear, Household goods and services, Health and personal care, Transport Recreation, culture, restaurants and hotels, Holidays, Other miscellaneous goods and services.”

Despite its worthy nature, the discussion paper smacks of a Regulator Knows Best approach. In pursuing this line of thinking, the FSA is treating individuals as ignorant, uninformed and in need of saving from their own errors and excesses. It makes no allowance for the ability of people to modify their spending and behaviour to save more. There is an absence of trust, especially of borrowers, in this document.

In fact the comments in the paper really reflect the horrible failure of the FSA to regulate mortgages and lenders during the boom years in the UK. It’s a crude attempt at catch up from a bunch of regulators still shell shocked by their failure, despite changes in management and approach.

The paper doesn’t seem to understand the impact that cutting or restricting home lending (and the size of loans) might do to the value of existing mortgages. If the changes force a fall in lending, demand for homes will decline, prices will weaken, putting pressure on existing home and mortgage values. Given that the UK economy will be weak, debt ladened and incomes won’t rise noticeably for several years, the FSA seems to be saying that it wants to put the home lending sector to sleep for some time to come.

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Peter Fray
Peter Fray
Editor-in-chief of Crikey
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