Building on outline discussions held in October 2009, the FSA wants to make lenders responsible for ensuring that first time buyer mortgage deals are affordable for the borrower, on the basis of stricter affordability tests to vet the customer’s ability to pay.

First time buyers mortgages will also require much stricter verification of household income, which has been interpreted as a virtual ban on the self-certified first time buyer mortgages, where the customer’s word was taken as enough to obtain first time buyer mortgage deals. Such submissions based on trust were the basis of almost half of mortgage deals from 2007 to the beginning of 2010, said the FSA.

The same guidelines will also require lenders to modify their ‘fast track’ procedures designed to speed up offers to borrowers with good credit records. Now, a standard evaluation procedure may be applied to all borrowers, regardless of their good credit history, where everything must be documented and all boxes must be ticked.

Many homes overstretched by mortgage repayments

The FSA also found that in 2005-2010, 46% of UK households used up all their monthly income, of even had to raise extra cash or credit, to pay their mortgage and living costs.

The FSA has identified that many overstretched homeowners are depending on uncertain future life events, such as an increase in property values, as part of their strategy to repay their mortgage. Other borrowers have taken interest-only deals, which accounted for over 30% of the market in recent years.

“There is a clear link between financial overstretch and mortgage arrears and repossessions, and we are determined to protect vulnerable consumers by making sure that everyone who takes on a mortgage can afford to pay it back,” said Lesley Titcomb, FSA director for the mortgage market.

The FSA’s consultation document will now form the basis of a public debate, due for completion this coming November.

In general, the drive of the FSA guidelines is to limit the number of homeowners who eventually find themselves in difficulty keeping up with their mortgage repayments.

By ensuring that the financial planning advice offered to those buying a mortgage comes only from fit and proper persons, such as an independent financial planner or other qualified provider of financial advice, homeowners can be more certain of taking on mortgage repayments that will be sustainable and manageable in the long term.

The benefits of independent financial advice were proven in a report by the Association of Mortgage Intermediaries (AMI) which stated that independent mortgage advice will save the average mortgage holder £962 per year in mortgage repayments.

This is because an independent mortgage adviser can take a ‘whole of market’ approach, comparing all mortgages on the market, to the best deal for the customer. Equally, independent remortgage advice will also identify whether staying with the existing lender or moving to a new deal is in the best interests of the customer. An adviser employed by or affiliated to a single lender, on the other hand, can offer only their own in-house range of mortgage deals.

The FSA’s guidelines also cautioned mortgage holders who are considering using ‘sale and let back’ companies to free up capital in their homes, by selling their home but continuing to live in it as a tenant. The FSA recommended security of tenure for sale-and-let-back customers for at least 5 years, and a 14-day ‘cooling off period’ for those opting to sell their home under such arrangements.

Government plans to raise Inheritance Tax allowances or the ‘nil rate band’ to £1m have been cancelled this week.

The Conservative Party had included as one of its flagship policies an undertaking to raise Inheritance Tax allowances to £1m per person, or £2m if transferred between couples.

As a result of the cancellation, Inheritance Tax allowances will now remain at present levels of £325,000 for an individual, or £650,000 for a couple, for the foreseeable future.

Inheritance Tax is levied at 40% on portions of your wealth or ‘estate’ above your Inheritance Tax allowance.

Your estate consists of the value of your home plus any other properties you may own, cars, valuables, savings, investments, and any life insurance policies you may have that are not written in trust. This total is then reduced by the value of your outstanding mortgage, loans and other debts. If the resulting total exceeds your personal allowances, you then deduct your personal allowance, and the resulting sum is subject to Inheritance Tax.

A simple scenario can show where Inheritance Tax can apply. A widow has a home valued at £300,000, a life insurance policy, not written in trust,  for £200,000, and other investments and savings totalling £100,000. This gives her assets of total value £600,000.

Her debts include £10,000 outstanding on her mortgage and £5,000 in assorted borrowings. Her debts and liabilities are therefore £15,000.

The value of her estate is therefore her assets (£600,000) less liabilities (£15,000), equalling £585,000.

Subtract from that her personal Inheritance Tax allowance of £325,000, giving a remainder of £260,000. This is the sum liable for Inheritance Tax at 40%, leaving her children with a demand from the taxman for an Inheritance Tax bill of £104,000.

With some financial planning and good independent financial advice, however, this Inheritance Tax liability could have been reduced, or eliminated altogether.

As a first step, a financial planner might, for example, have recommended writing the widow’s life insurance cover in trust. This is a simple means of removing her life cover from her estate, thus reducing the value of her estate by £200,000, and leaving her with just £60,000 liable for Inheritance Tax. This step alone would have reduced the value of the Inheritance Tax bill to just £12,000. However, further steps are also possible which would, with the help of a good financial planner, have enabled her to further reduce her exposure to Inheritance Tax.

The new guidelines also indicate that mortgage deals classified as sub-prime lending by building societies could possibly be upgraded to prime status, once loans have been performing for 5 years.

The changes come into effect on 1 April, and must be implemented by 30 September.

Citing the Building Societies Act as its authority, the FSA has said that building societies unable to show ‘appropriate risk managment and skills’  in mortgage lending would be ‘steered’ to tighten up their controls, or switch to simpler business models that were easier to monitor.

The guidelines may encourage building societies to restrict already-tight definitions of ‘affordability’, which analyse the financial situations of borrowers and make a decision on how much debt they can comfortably sustain, before offering them a mortgage deal. The guidelines may put downward pressure on the size of mortgage deals made available to customers, on a case by case basis.

Two years ago the FSA coined the term ’toxic lending’ to describe the provision of loans that were high in relation to the paying power of borrowers, and which contributed to financial hardship and mortgage payment defaults, during the subsequent recession.

The creation of the Consumer Financial Education Body (CFEB) was announced in the Financial Services Bill now before parliament and will be staffed by 160 staff drawn mainly from the Financial Capability Division of the Financial Services Authority (FSA).

Although the FSA will have “certain oversight responsibilities” for the new body, the CFEB will be independent, with its own CEO, chairman and board.

The operations of the CFEB are likely to include a national telephone adviceline, a website and face-to-face financial guidance.

According to the information provided on the brief of the new body, the CFEB  will aim “to make a tangible difference to quality of life for millions in the UK, by helping them to manage their finances effectively and avoid getting into unmanageable debt.”

The Treasury has estimated the cost of the new service in the long-term at up to £2.7bn.

There are currently £2.5 trillion in assets earmarked by parents as inheritances for their children and relatives, the insurer announced this week.

This staggering sum is held by two-thirds of over-55s covered by an Aviva survey*, with 58% of those questioned wishing to bequeath assets to their family and 46% mentioning specifically the family home as the principal asset they will leave.

Given that Inheritance Tax applies to all eligible wealth at 40%, you can see why the taxman might be rubbing his hands with glee.

However, any financial adviser worth his salt will tell you that, with a little financial planning, Inheritance Tax is the most avoidable tax of all, and can be minimised or eliminated completely by putting the correct structures in place.

Each person has an Inheritance Tax allowance of £325,000 (double that for a couple to £650,000). Where the value of your wealth exceeds that allowance, it is subject to Inheritance Tax at 40%.

While these ‘nil rate band’ allowances seem generous, they apply to your whole estate.

This consists of your home, other properties, savings and investments, insurance policies, other assets, and cars. Take away the amount of your debts and liabilities upon death, and you have the net value of your estate.

Life insurance in trust

By using a trust you can move assets out of your estate, so that their value does not push your net worth up towards the threshold at which you become liable for Inheritance Tax.

By filling out a simple form when taking out a life policy, you can hold the life insurance in trust so that the cover does not inflate the value of your estate. An added advantage is that the payout from the life insurance policy will not be held back upon your death, but paid quickly and efficiently to your family.

Inheritance Tax exemptions

One tax-savvy way to transfer wealth to your children is by making gifts that are not subject to Inheritance Tax - so-called Inheritance Tax exemptions.

There are various kinds of IHT exemptions, subject of course to the limitations of the Inheritance Tax allowances:

• Spouse exemptions
• Small gift exemptions, of up to £250 to any number of persons in a given year
• Annual exemptions to your children of £3,000 per year
• Wedding exemptions of £5,000 to a child or £2,500 to a grandchild when they marry
• Regular gifts of a ‘reasonable size’ to be classed as part of your normal expenditure – for instance maintenance payments or funds for a child in full-time education

There are also a number of ‘potentially exempt’ gifts, known as potential exempt transfers or PETs.

These are only ‘potentially’ exempt because they are not immediately free of tax. You must survive for 7 years after making the gift, before it becomes tax exempt. In other words, a gift made in 2010 becomes tax-free only if and when you have survived until 2017.

The most common PET is probably the family home, transferred to your children and becoming tax-free 7 years later.

There is one important catch with regard to transferring your home, however. If you continue to benefit from the home, by living there, it is classed as a ‘gift with reservation’ and is still subject to tax.

This can be avoided if you set up an arrangement to pay your children rent at a commercial rate, in which case you are viewed as a tenant.

Source: Aviva online poll of 1,337 UK adults

The recent recession has taught one very important lesson, according to Ed Harley, head of mortgage policy at the Financial Services Authority. 

“It has taught me the importance of being prepared to review your assumptions about how markets work… Some of the assumptions that underlay our original approach to mortgage conduct of business, some of those assumptions about how customers interact with financial services, how rational they are and how rationally sometimes even firms operate, have been challenged by the recent financial markets,” he said. 

Consumers at risk of burdening themselves with an unsustainable debt have emphasised more than ever the need for the voice of reason that is provided by a good financial adviser, who can, among other things, calculate what their desired property would entail, in terms of  mortgage repayments. 

“What we have tried to do is recognise the importance and the way that a face-to-face discussion with a consumer is a unique opportunity to understand what their needs are, and what their circumstances are,” he said. 

What the FSA seeks is to ensure that mortgages are not given to those for whom they would bring an unmanageable burden of debt. As such, the notion of ‘affordability’ was a safety measure to protect vulnerable consumers, and not a barrier to obtaining a mortgage. 

The Self-Certification Mortgage Issue 

Ed Harley stated that, again, the issue of demanding income for self certification mortgage applicants should be seen as a safety measure, and not an attempt to exclude anyone from the mortgage market. 

“What we do not understand is why a self-employed person cannot provide any verification of their income,” he said. 

While self-employed people unable to support repaying a mortgage should recognise that, Ed Harley emphasised that, equally, it was essential that those who can are able to get one. 

With that in mind, the demands for documentation should be firm but reasonable: “Across the industry there are practices where income verification implies a number of years of salary information or a number of months of bank accounts to verify the income is there. We do not necessarily think that level of income verification is required.” 

Lenders and the FSA should now sit down and define what a good definition of ‘income verification’ might be, he said.

The Financial Services Authority is also to regulate third parties who buy mortgages from lenders, to provide additional security to mortgage borrowers. 

Regulation by the Financial Services Authority of hedge funds and private equity firms who buy up mortgage books from lenders should ensure that mortgage borrowers are protected from repossession in the same way that they would be if their loans were with traditional mortgage lenders. 

The new measures dovetail with the government’s existing measures to protect mortgage holders through the Homeowner Mortgage Support Scheme, which was introduced in April this year. 

The Scheme works with leading mortgage lenders including Lloyds/Halifax, RBS, Bradford & Bingley, and Cheltenham and Gloucester to offer mortgage borrowers who suffer a loss of income the opportunity to cut the interest repayments on their mortgages for up to 2 years.

“The FSA’s proposals on self-cert mortgages will not block access to the market for the self-employed,” said Lesley Titcomb of the FSA this week. 

This follows the publication in September of a number of proposed guidelines by the FSA to ensure more cautious strategies by mortgage lenders. 

One of the proposals was that all lenders should require verification of a mortgage applicant’s income, which meant an end to self-certified mortgages where the bank accepted on trust an applicant’s declaration of what he or she earned. 

This was widely regarded as a limitation of the scope to obtain a mortgage by those self-employed people whose income fluctuated, or who were unable to provide professionally prepared accounts. 

It was also seen as a response to those borrowers who exaggerated their income on a self-cert mortgage application, in order to obtain a larger mortgage and thus increase the likelihood that they would at some time have difficulty with mortgage repayments. 

The FSA also proposed banning the sale of mortgages based on certain ‘toxic combinations’ that led to a higher risk of repayment problems. These could include giving mortgages with a high loan-to-value ratio (i.e. mortgages equal to 90% or more of a property’s value) to borrowers with imperfect credit. 

Another ‘toxic combination’ would result when a mortgage lender took a soft view of the ‘affordability’ of a loan for the individual client, and thus providing them with a mortgage that would eat up an unjustifiably large amount of their monthly household income.

 GMAC’s failings included “excessive and unfair” arrears charges for missed mortgage payments on loans, repayment plans that did not always consider a customer’s circumstances, and moving to repossess when this was not a last resort.

GMAC must now also repay up to £7.7m in redress to over 46,000 mortgage customers who had experienced arrears and repossessions.

Moreover, the case sets a precedent which, according to the FSA, should be heeded by other lenders, whom it urged to ‘sit up and take notice’ of the outcome of its investigation.

“This case shows credible deterrence in action. It is an excellent example of what the FSA’s more intrusive approach can achieve for consumers,” said Margaret Cole, director of Enforcement and Financial Crime at the FSA.

“Mortgage lenders and third party administrators should read this final notice … and take action in the interests of their customers.”

 GMAC was allowed a 30% reduction in its fine for cooperating to ensure a speedy conclusion to the investigation, under the FSA’s settlement discount scheme. The full fine would have been £4m.