Statutory regulation of mortgages is scheduled to take effe ct no later than August 2002, on a date described as N3.

Mortgage lenders will have to be authorised by the Financial Services Authority (FSA) with specific permission to lend on mortgage.

Mortgage brokers will not need to be authorised unless they carry on investment business, such as advising on endowment policies.The FSA will regulate mortgage advertising and require mortgage lending activity to include specific disclosure on the main features of the loan at various stages in the transaction.Last month the Treasury published consultation paper 98, the Draft Mortgage Sourcebook, including Policy Statement onCP 70.The introduction of statutory regulation is designed to compliment the voluntary mortgage code operated by the Council of Mortgage Lenders and monitored and enforced by the Mortgage Code Compliance Board.

The code sets out minimum standards which mortgage lenders and intermediaries have to meet.

The standards are encompassed in ten key commitments and mortgage advice will remain self-regulated and will not come within the proposed statutory regulation.

The omission of mortgage advice from statutory regulation has invited criticism from various quarters.Regulated mortgage contractsSection 22 of the Financial Services and Markets Act 2000 allows the Treasury to specify what is a regulated activity 'by order' and this power was used to make The Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 [SI 2001/544] (the RAO).

Under the RAO the following conditions must all be satisfied to enable a mortgage to be regulated by the FSA:-- The borrower must be an individual or trustee;-- The contract must be entered into after mortgage regulation comes into force (this date being N3 and currently expected to be no later than August 2002);-- The lender must take a first charge over UK property; and-- The property must be at least 40% occupied by the borrower or his immediate family.In addition, the FSA has decided to limit the scope of its rules to mortgages where the borrower is in the UK at the time the mortgage contract is entered into.The parameters of the definition of a regulated mortgage contract mean that the FSA will be responsible for the regulation of house purchase mortgages and various other kinds of lending, providing they are secured on property and satisfy the conditions mentioned earlier.Regulated mortgage activitiesThe RAO will require firms to be authorised by the FSA if they are to carry on one or other of two regulated activities: entering into a regulated mortgage contract as a lender; and administering a regulated mortgage contract, that is, notifying borrowers of changes to mortgage payments and/or collecting payments due under the mortgage (the mortgage administrator may be the same firm as the mortgage lender or a different firm).

The RAO also removes both mortgages and financial promotions from regulation under the Consumer Credit Act 1974 if they are subject to the FSA's regime.It is worth noting that some types of firms are not subject to statutory regulation including securitisation special purpose vehicles and local authorities and registered social landlords.Rules and guidanceThe proposed mortgage-specific rules and guidance are contained in the draft Mortgage Sourcebook, included within consultation paper 98.

The detailed proposals cover among other things:-- Rules relating to the content of financial promotion;-- Disclosure requirements before and after sale;-- Arrears and repossessions;-- Charges;-- Cooling off; and-- Capital and othe r prudential requirements.Financial promotionsFinancial promotions of all secured lending products by firms authorised by the FSA are governed by the Financial Services and Markets Act 2000 (Financial Promotion) Order 2001 [SI 2001/1335] (the FPO).These financial promotions known as qualifying credit promotions cover lending which is wider in scope than regulated mortgage contracts.

For example, it extends to second charge loans and to unsecured loan facilities which form part of the regulated mortgage contract.

The draft rules governing qualifying credit promotions present a dilemma to unauthorised firms (particularly intermediaries), as they will need to ensure that before they issue any such promotion, it has been approved by an authorised firm.The draft rules for the content of financial promotions require all advertisements to be clear, fair and not misleading and there is a requirement for balance in respect of benefits and drawbacks.

Also the APR must be clearly stated.Disclosure requirementsThe draft rules on disclosure require a lender to provide information at four stages in the transaction:-- Before the customer submits an application form to the lender;-- At the time the lender makes an offer to the customer;-- At the start of the mortgage period before the first payment is due; and-- Over the life of the mortgage.Customers are to receive a personalised pre-application illustration to enable them to shop around between different lenders and to help them understand the comparative terms.Approximately 40% of all mortgage sales are made via intermediaries and the FSA will require lenders to take reasonable steps to ensure that intermediaries provide this information to the customer.

This issue is one of the hot topics under discussion in the consultation process.

Lenders are concerned with the direct costs, market impact and practicalities of monitoring and enforcing this requirement upon intermediaries.

What is meant by reasonable steps is defined in the draft rules which state that this can be achieved either by the lender monitoring the intermediary to check that the information has been provided, or by obtaining a signed confirmation from the customer confirming that the information was provided.As well as the Mortgage Sourcebook, certain parts of FSA Handbook will apply to lenders, particularly the high-level standards contained in block 1.

There is an overarching requirement on lenders to pay due regard to the interests of their customers and to treat them fairly in accordance with principle 6 of the FSA's principles for businesses.Other requirementsThe draft Mortgage Sourcebook also contains rules on the treatment of customers after the point of sale.

These draft rules not only cover the information to be provided to customers who are in arrears, but also the fair treatment of customers who are in payment difficulties.

Consultation paper 98 also introduces safeguards preventing exploitative practices, including rules requiring disclosure of early repayment charges and arrears charges.

There is also proposed provision for a cooling off period in cases of non-property purchase lending, such as home improvement lending and loans for debt consolidation.Capital requirementConsultation paper 98 sets out the capital adequacy requirement for authorisation.

The FSA proposes two alternative bases for calculating the capital requirement -- 1% of total assets or 20% of total income -- and a minimum capital requirement of £100,000 for mortgage lenders or administrators that are currently unautho rised.

The proposed capital requirement for firms which administer mortgages, but do not have the mortgage assets on their balance sheets is 10% of total income (again subject to a minimum requirement of £100,000).The industry's responses to consultation paper 98 are required by 14 September 2001.