Opening Statement by George Treacy, Head of Legal and Consumer Departments to the Joint Committee on Finance and the Public Service

Introduction

Good Afternoon. Thank you Chairman and Members of the Committee for your invitation to appear here today to discuss the application of fees by lenders on the early redemption of fixed rate mortgages. I am joined here today by my colleague Fiona McMahon, Deputy Head of Consumer Protection Codes Department.

There are two main reasons why borrowers seek to exit a fixed rate mortgage early, either they are in a position to pay off the mortgage early or, as is more likely in today’s low interest rate environment, to try to avail of a new fixed or variable rate agreements. Borrowers who have chosen to repay fixed rate mortgages early have found themselves faced with, in many cases, a substantial early redemption fee. This has been the source of calls to our helpline and complaints to both lenders directly and to the Financial Services Ombudsman. It has also generated significant comment.

In response the Financial Regulator undertook an examination of the manner in which such fees were calculated and applied. I would like to briefly outline for you the steps that the Financial Regulator has taken in its examination and our findings. I will also mention some further follow-on work we are currently undertaking.

In order to assist the Committee in its deliberations I forwarded a copy of our report to your clerk in advance.

Consumer Credit Act 1995 (the Act)

Under the Consumer Credit Act, credit institutions and prescribed credit institutions must make a submission to the Financial Regulator if they wish to introduce any new customer charges or increase any existing customer charges in respect of services such as providing and granting payments. The Act requires us to assess such submissions according to the criteria of fair competition, impact on customers, commercial justification and passing on costs. We either reject the proposal, accept the proposal but at lower levels than requested by the firm or approve the charge in full.

However, while the term ‘charge’ includes penalty or surcharge interest, the Act specifically excludes rates of interest and any charge, cost or expense levied by a third party and passed on by an institution to customers. Lenders normally fund a fixed rate mortgage through the wholesale market and as such it is deemed to be a third party cost of the credit provider. Therefore where an institution uses a formula to calculate the costs it will bear as a result of the early redemption of a fixed rate mortgage it does not fall under the definition of a charge, it is effectively a pass through charge and as such the formula and resulting charge does not fall to be approved or notified to the Financial Regulator.

Exiting fixed rate mortgages

The Consumer Credit Act clearly contemplates that lenders will charge an early redemption fee where the borrower seeks to repay a fixed rate mortgage early. Section 121 of the Act deals with the redemption of housing loans. It requires that where an early redemption fee is payable a statement to that effect must be included in the information offer and acceptance documentation related to the mortgage. Our statutory Consumer Protection Code also requires that advertising in relation to fixed rate loans must, where applicable, outline that charges may apply where you pay off a fixed rate loan early.

Borrowers opt for fixed rate mortgages as the fixed repayments facilitate budgeting and protect against future interest rate increases. However, borrowers on fixed rate mortgages clearly do not benefit from falls in interest rates. In the current environment, interest rates have fallen substantially. Consequently a substantial differential may have arisen between the interest rate that the credit provider has locked into for the funds supplied to customers and the rates available for the reinvestment of the early repayment amount for the remaining period of the fixed rate loan. The breakage or early redemption fee to move out of a fixed mortgage can be considerable. This will depend critically on how much time is left on the fixed rate mortgage, what the fixed rate was and the amount owed on the mortgage. As interest rates have fallen, the level of calls from consumers received on our helpline have increased and we received 526 calls about fixed rate mortgage breakage fees in the period January to June 2009.

Examination

We commenced our review in April this year seeking information in relation to the early redemption formula applied by lenders, including a worked example. In addition to this where the institution confirmed to us that the early redemption formula applied by them was limited to recovering the cost of funding of the particular fixed rate agreement, actuarial confirmation was sought of the formula. Lenders were also requested to confirm that where other fees were being applied that approval under the Consumer Credit Act had been obtained. We have now analysed all of the information gathered. The information and actuarial reports that we have received indicate that lenders are seeking to cover their costs in the application of early redemption charges and in the majority of cases, no additional fees, which would need to be approved by the Financial Regulator, are being imposed.

While much of our examination has been desk based, essentially reviewing and assessing the reports provided, we recognise the importance of verifying the accuracy of the information received and in this regard we have commenced a programme of onsite inspections of firms. While all of the actuarial reports received confirmed that lenders are genuinely seeking to recover the costs of funds, we are following up on some ancillary issues raised by the reports received. These matters include the fact that one report discussed the impact of using a mix of funding of different durations on the relationship between the redemption fee and the funding breakage cost.

Another report discussed the use of different breakage fee formula depending on whether the customer was moving to another mortgage product or making a full loan repayment. In addition to pursuing a programme of inspections we have also written to all lenders seeking additional information in relation to matters such the level of redemptions taken up by customers and including such details as a breakdown of the maturity profile of the fixed rate mortgage book and the associated maturity of the funding of that book, in addition to details about how the early redemption charge is documented in the terms and conditions received by customers. This work is ongoing.

Conclusion

While recognising the significant costs that currently arise in the application of an early redemption charge to fixed rate mortgages, it is important to recognise that fixed rate mortgages are nevertheless an important product. They provide certainty to consumers regarding the level of their monthly repayments and the current low interest rate environment will not last forever.

Notwithstanding our findings as set out above and in our report, lenders can and do make mistakes. The Financial Regulator would strongly advise that any borrower who believes that they have been charged an excessive early redemption charge should request their lending institution to provide a clear explanation of how the cost was calculated. In the event that the borrower is not satisfied with the explanation, a formal complaint should be made to the lender and in the event of an unsatisfactory response, he or she should exercise their option to refer the matter to the Financial Services Ombudsman who will independently adjudicate on the matter.

Finally, as our work in this area continues, we have also provided consumer information on www.itsyourmoney.ie urging consumers to fully inform themselves about the consequences of changing the terms and conditions of existing mortgages and loans. We have provided information on the pros and cons of fixed rate mortgages as some borrowers are now considering fixing as interest rates are at an historic low. Separately, we have introduced a code for handling residential mortgage arrears and have written to lenders warning them that mortgage holders who seek to address issues before they become problematic should be treated fairly. We are happy now to take any questions you may have on this issue.