The Financial Conduct Authority has found "significant issues" in the second charge lending market and told all firms providing this service to review their processes.
The watchdog made the remarks following a review of the second charge lending market to assess how firms were adapting to the new regulatory regime brought about by the Mortgage Credit Directive.
The FCA found some firms were not basing their lending decisions on income and expenditure assessments and in some instances the regulator said it had proved difficult to follow how a lender had carried out affordability stress testing.
This was particularly noticeable where a loan had been approved outside a firm's lending policy, the FCA said.
The FCA also found practices which could leave second charge lenders vulnerable to becoming involved in financial crime.
In a letter sent to the chief executives of all second charge lenders, Jonathan Davidson, director of supervision at the FCA, said: "Our review found that second charge lenders appear too ready to accept supporting documents at face value, without carrying out further due diligence or authenticity checks.
"This could lead to them being implicated in financial crime.
"We identified instances in which firms were vulnerable to fraud by accepting evidence of income that could easily be manipulated by the customer.
"We found that some lenders were accepting what appeared to be self-assessment 302 documents but which were screenshots of income tax calculations lifted from the HMRC website.
"However, the content of these screenshots could subsequently be amended when the applicant proceeded to the next stage and completed the tax return."
Mr Davidson said firms had until 1 May to review their practices and confirm in writing to the FCA that this had been carried out.
Among the other concerns the FCA found was that income assessment for self-employed customers was often "very poorly handled".
In some cases the FCA was unable to identify where an underwriter had obtained the figures used for net income and found evidence lenders were not always taking account of tax and national insurance deductions and were relying on calculations contained within accountants' certificates and other documents that did not appear to be plausible or realistic.
The FCA also found firms were not always using realistic assumptions for expenditure assessment, which was particularly evident when customers were consolidating a number of debts.
As part of the review, the FCA looked at lending policy documents and individual lending files to assess whether firms could show they were lending in line with the rules.
Ray Boulger, senior technical manager at John Charcol, said: "Second charge mortgages have only been regulated by the FCA for a short period of time and the underwriting processes were certainly looser than the first charge market.
"It is hard to argue against the principal that whatever rules are deemed to be appropriate for first charge lending should also be applicable for second charge lending. In fact since a first charge mortgage take precedence you could argue it should be stricter."
Fiona Hoyle, head of consumer and mortgage finance at the Finance & Leasing Association, said: "The FCA’s Dear CEO letter acknowledges that firms have already taken action to improve affordability calculations and that some income assessments are working well – but it does also identify where further work is required, which will help firms to fully embed the new regime.
"The industry has been through a period of demanding regulatory change, having been given only nine months to implement the Mortgage Conduct of Business regime. This early insight into where additional change is required will assist firms prioritise their compliance work."
damian.fantato@ft.com
