The MCD - effects on foreign currency mortgages and buy-to-let
As we wrote in our first blog on the subject, the Mortgage Credit Directive (MCD) is a piece of European legislation which is designed to create a single market for first and second charge mortgages and to protect consumers by stress-testing their ability to repay a mortgage in changing economic circumstances. It will be implemented in the UK through rules drawn up by the Bank of England’s Financial Conduct Authority (FCA) and will take formal effect from 21 March 2016, although a number of changes have already taken place – or are in the process of doing so – as mortgage lenders pre-empt the imposition of the MCD, just as they did in advance of the Mortgage Market Review (MMR) in April 2014.
In particular, lenders have been making changes to their criteria and these changes are beginning to have an effect on borrowers in the areas of both foreign currency loans and some buy to let mortgages.
Foreign currency loans
The lending requirements that relate to foreign currency loans will change, making them less attractive for lenders to offer. As a result, a number of lenders have pulled out from lending to borrowers based overseas or earning in a foreign currency. However, some of the more experienced lenders in this market have not withdrawn as they already factor currency risk into their assessment of the applicant's total income.
So what is the definition of a foreign currency mortgage in this case? Simply put, if your income is in a currency that is different to that which applies to the mortgage on the property you own, then you are a foreign currency [FC] borrower – even if you live in the country and your wages are paid into a bank account in that country. So if you live in the UK and you are paid in euros or dollars then you would be taking out an FC mortgage where your mortgage is in sterling.
The key MCD statement says:
Where an MCD regulated mortgage contract relates to a foreign currency loan, […] the MCD mortgage lender must ensure:
1. the consumer has a right to convert the MCD regulated mortgage contract into an alternative currency under specified conditions; or
2. there are other arrangements in place to limit the exchange rate risk to which the consumer is exposed under the MCD regulated mortgage contract.
What this means is that if you take out a FC mortgage and the exchange rate between the two currencies moves by more than, say, 20% you may have the right to move your mortgage to an alternative currency, particularly if you prove it is no longer affordable. Alternatively, if the lender could cap your risk, for example if the exchange rate has gone up by 25%, the lender can agree to cap the amount payable to no more than 20%. This means that the lender has to share the risk of any currency fluctuation.
Unfortunately the new rules do mean it isn’t cost effective for some lenders to manage the currency risk - they are unwilling or unable (due to lack of IT systems flexibility) to manage it. Others are still willing and able; they already deduct around 25% of income to guard against currency fluctuations and they will continue to do so.
Advice for applicants who may be affected is available from independent brokers with a special focus on UK residents who earn some or all of their income in a foreign currency.
Buy to Let (BTL)
The MCD requires EU member states to develop a ‘national framework’ for BTL lending if they choose to exercise discretion afforded by the MCD to not apply the MCD to their BTL mortgage markets. The UK is exercising this discretion and has created a regulatory framework for BTL lending to consumers called 'Consumer buy-to-let' (CBTL) – to take effect from March 2016 - leaving BTL mortgages for business purposes unregulated.
The regulation of ‘Consumer buy-to-let’ mortgages by the FCA could cause a reduction in the growth of this recently buoyant sector. For example, Nationwide Building Society has recently set out its approach to the new rules, with plans to implement the requirements ahead of the March 2016 deadline. In order to identify ‘Consumer buy-to-let’ customers, the lender will add further questions to its mortgage application form and brokers have been notified that they will need to have the appropriate permissions and be fully registered with the Financial Conduct Authority (FCA) to conduct ‘consumer buy-to-let’ business.
However, the FCA has clarified that if a buy-to-let loan is for a property that has been bought for business purposes (i.e. by a limited company) and for the sole purpose of letting it out, it will remain unregulated. Equally, if the borrower has never lived in the property and has a portfolio of properties, any mortgage funding that portfolio also remains unregulated.
Lenders can also confirm a loan is unregulated if the borrower signs a declaration saying that the mortgage is wholly for business purposes and the provider has no reason to think otherwise.
Other exemptions to consumer regulation include properties where a portion of the property is being used as a residential dwelling for the borrower or a relative or where the property is mainly a business, like a secured loan on a bed and breakfast business, for example.
An impact assessment by the Building Societies Association suggests just 11% of the market, or 18,000 transactions, will be affected by the consumer buy-to-let regulation changes.
As we stated in our first blog on the subject, it is unlikely that the MCD will cause lending activity to stall in 2016. We have a dynamic and innovative mortgage market in the UK and it will adjust to the MCD, just as it has adjusted to new regulatory requirements in the past.