I was discussing mortgages with a couple of colleagues recently; not the most exciting of subjects perhaps, but one of those essential things that affects most of us who’ve not yet won the jackpot on the lottery.
We got onto the additional checks and verification that have now become the ‘norm’ by way of the new regulations arising from the financial crisis in the late 2000’s, and coupled that with a bit of real-life experience amongst our group.
The subject of the ‘affordability check’ came up which, if you’re not familiar with it, is essentially the bank (who most likely don’t have the faintest idea about you or your financial management skills) deciding whether you (who does know about yourself and your financial management skills in great detail) can afford to meet your mortgage payments using their generalised model rather than your own personalised data from your real life history.
Now I’m fully aware that a sizeable proportion of the financial sector professionals reading this will be shaking their heads at their screens and probably readying a pointed comment or two to add to the bottom of this, along the lines of “but we do use a customer’s personal data in the checks”, and that’s true to a certain extent. But it’s applied to the bank’s and Financial Conduct Authority’s (FCA’s) model of what it thinks the generalised population can afford, and not the individual in question, their banking history, or how they evidently manage their finances. Let’s also remember that the risk of the bank losing all their money from a mortgage is very low thanks to their ability to repossess the property if things go wrong.
"Very responsible . . . and also entirely irrelevant if the mortgage rate is being fixed!"
We talked about the stress testing that goes on too, where a theoretically higher interest rate is applied to test if the mortgage payments remain affordable should interest rates rise. Very responsible . . . and also entirely irrelevant if the mortgage rate is being fixed!
The quieter member of our group spoke up: “ah, but that’s to check affordability when the fixed period ends”. True. But the switched-on customer (and this is where my view comes in of it being one of the bank’s/FCA’s jobs to enable customers to become switched-on) switches their mortgage to a new more competitive deal, rather than sticking with the over-inflated standard variable rate that most mortgage deals eventually default to.
On the face of it, it all sounds great; banks being responsible lenders, a strong regulatory regime, and a competitive market. Customers are protected from those pesky unscrupulous lenders than contributed to the financial crisis, right?
Wrong.
The reality of the situation here, is that those affordability checks coupled with the banks’ knowledge of customers’ likelihoods of successfully passing them and being ‘permitted’ to have a competitive new mortgage deal actually end up causing customers to pay more.
Here’s how:
your mortgage deal is coming to an end
you shop around and find a great new deal with another bank
you can see you can continue to afford it as your financial status hasn’t changed and this new deal is at least as competitive as your current one . . . life’s good!
you apply for the deal with the new lender
the affordability check is applied
you get rejected.
"You then have no choice but to go back to your current lender"
You then have no choice but to go back to your current lender and choose from their highly restricted choice of existing customer ‘deals’ with rates that are far higher than the most competitive they offer to new customers (but a little lower than the standard variable rate). They don’t have to apply the affordability checks because apparently they already ‘know’ you, and they scoop up the profits of the higher interest rate thanks to you being a ‘loyal’ (or more accurately, locked-in) customer.
Even over a 2-year deal, these rates can lead to customers paying thousands of pounds more interest than they would otherwise have done had they been able to choose the most competitive deal from that lender or from the wider market. If a great deal is available to new customers, then the market should be freely open such that it’s available to all customers; that’s what “treating customers fairly” really means in the eyes of the customer.
"That’s what “treating customers fairly” really means in the eyes of the customer"
A colleague of mine was actually told by a mortgage advisor in a bank to sell his car so he could pass the affordability check . . . which of course meant that he wouldn’t be able to get to work to earn the money to pay the mortgage! Computer says, “that’s now affordable”. Reality says, “are you kidding??”.
I’m in no doubt that the new regulations were well meaning, designed to protect customers from unscrupulous lenders and ensure people have the best chance of being able to pay their mortgage well beyond the foreseeable future.
Unfortunately, those same regulations now lead to perfectly financially stable customers ending up locked-in on higher rates because the regulations prevent them from switching, thereby costing them substantially more in interest.
An appropriately qualified friend put it rather well:
“because a small number of lenders behaved badly by offering loans they knew full well that customers couldn’t afford, we’ve gone to the other extreme where all adults have to be treated like children and are told what they’re allowed to afford”
Harsh, but fair.
And this brings me onto the point of this post . . . beware the unintended consequences!
I’ve observed similar examples of unintended consequences in a variety of sectors, typically around policies, rules and performance measures. It generally goes like this: the more constraints you have and the more rigid they are, then the more case studies you can find of people falling through the gaps, being locked out or being locked in . . . and the more workarounds and loopholes that are created for the less-than-reputable to take advantage of (see also: any part of the taxation system). Try to apply reason and discussion to these rules, and the standard answer comes out: “computer says no”!
"Try to apply reason and discussion to these rules, and the standard answer comes out: “computer says no”!"
A far better approach for avoiding unintended consequences and still being responsible, especially where a high level of variability exists in the uncontrollable inputs (i.e. the customers in the mortgage example), is to apply key principles with permissible tolerances around the important measures, and use real personal data to drive decision making on a more individual basis; guiding those customers where necessary and making them fully and clearly aware of what they are signing up to.
Furthermore, enable customers to understand the market before they need to make use of it such that they're informed in their decisions, and that includes simplifying products and terminology (because we all know what a mortgage “redemption overhang” is, right?!). With all the technological advances in data processing and the vast quantity of our data stored by corporations, this should be entirely possible with a bit of careful thought, as should a bit of time and care for the individual customer.
We have to start to empower and trust people to be responsible for their own world and their own actions, whether that be at work or in life in general. Educating ahead of the need for the skills and supporting when help is needed. Only that way can we raise the level of understanding, prevent everyone being forced down to the lowest level, and really start to eliminate those unintended consequences that can be costly, painful, and inefficient for everyone involved.
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Artwork copyright Geoff Davenport 2019.