Bank of England drops mortgage market affordability test after less than a decade
The Bank of England said this morning that its Financial Policy Committee will withdraw the so-called mortgage market affordability test.
“Following its latest review of the mortgage market, the Financial Policy Committee has confirmed that it will withdraw its affordability test Recommendation,” the BoE said in a statement.
This will come into effect from 1 August 2022.
Stress interest rate
Introduced in 2014, the test specifies a stress interest rate for lenders when assessing prospective borrowers’ ability to repay a mortgage.
“The recommendations were introduced to guard against a loosening in mortgage underwriting standards and a material increase in household indebtedness that could in turn amplify an economic downturn and so increase financial stability risks,” the bank explained in a statement.
The FPC has regularly reviewed these kinds of recommendations. In its latest review, published in the December 2021 Financial Stability Report, the FPC judged that the LTI flow limit is likely to play a stronger role than the affordability test in guarding against an increase in aggregate household indebtedness and the number of highly indebted households in a scenario of rapidly rising house prices.
“Therefore the LTI flow limit without the affordability test, but alongside the wider assessment of affordability required by the FCA’s Mortgage
Conduct of Business (MCOB) responsible lending rules, ought to deliver the appropriate level of resilience to the UK financial system, but in a simpler, more predictable and more proportionate way,” the bank stressed.
When two mortgage recommendations were introduced eight years ago, it was to help guard against a significant increase in household indebtedness that may make any economic downturn worse.
These were a loan-to-income (LTI) limit and the affordability test, which specifies a “stress interest rate” for lenders to consider when assessing a potential borrower’s ability to repay a mortgage over time.
The LTI limit, which will remain in place, limits the number of mortgages that can be extended to borrowers at LTI ratios at or greater than 4.5.
According to data from Rightmove released today, the average asking price across Britain stands at £368,614 – with June marking the fifth month in a row that it has hit a record high.
Gemma Harle, managing director at Quilter Financial Planning, said: “While it is potentially bad timing for the announcement, the change in the affordability rules may not be as significant as it sounds as the loan-to-income (LTI) ‘flow limit’ will not be withdrawn, which has much greater impact on people’s ability to borrow.
“Although the shift in rules is one of the many attempts to help first-time buyers get their foot on the ladder, it may end up having the opposite effect.”
Gemma Harle
“One of the main drivers behind ‘generation rent’ is the fact that house prices have massively outstripped wage growth. Due to high house prices, first-time buyers also need very sizable deposits and in the current fiscal environment saving this type of money will be very difficult due to increasing rents and the cost of living.
“On top of this, inflation will be eating away at any other savings they have sitting in cash.
“House prices have become further and further out of reach for prospective buyers and this change in the affordability rules could perpetuate unsustainable further growth as it steps up demand in a market already suffering with limited stock.”
The Government recently announced an extension of the Right to Buy scheme in England and an independent review of access to mortgage finance for first-time buyers, with the aim of widening access to low-cost, low-deposit finance such as 5% deposit mortgages.
The Bank’s Financial Policy Committee (FPC) judged that the LTI flow limit is likely to play a stronger role than the affordability test in guarding against an increase in overall household indebtedness and the number of highly indebted households in a scenario of rapidly rising house prices.
Therefore the LTI limit without the affordability test, but alongside the wider assessment of affordability required by the Financial Conduct Authority (FCA)’s responsible lending rules, should deliver the appropriate level of resilience to the UK financial system, but in a simpler, more predictable and more proportionate way, the Bank said.
The Bank added that the majority of consultation responses were supportive of the proposals.
It said lenders do not need to make changes as a result, as current affordability assessments should already be compliant with the FCA’s responsible lending rules.
Evidence from previous recessions suggests that in an economic downturn, highly indebted households are more likely to cut spending sharply, having the effect of amplifying downturns.
Struggling to afford home loans
Some potential borrowers may find it more of a struggle to afford a home loan in any case as the mortgage rates being offered by lenders are creeping up, following a string of Bank of England base rate hikes.
Financial information website Moneyfacts.co.uk said on Monday that the average mortgage standard variable rate (SVR) reached 4.91% in June, marking the highest level it has recorded since February 2009.
Mortgage borrowers may end up on an SVR when their initial deal comes to an end. The average overall two-year fixed-rate mortgage stands at 3.25% – the highest since November 2014 – Moneyfacts said.
The overall five-year fixed-rate average sits at 3.37% and is the highest on Moneyfacts’ records since June 2015. The average two-year tracker rate is 2.54% – the highest since September 2014.
The Moneyfacts averages take all deposit sizes into account.
Eleanor Williams, a finance expert at Moneyfacts, said the 0.12 percentage point gap between the average two and five-year fixed rates is the smallest the website has seen since 2013.
She continued: “Average rates for those with higher levels of equity or deposit have seen some of the steepest increases, which may come as a surprise as products at this end of the LTV (loan-to-value) spectrum have traditionally been priced lower, in part due to the smaller risk of default they tend to pose for providers.”
Response from industry
Discussing the decision to withdraw the test, Lawrence Bowles, director of research at Savills, told Morning Wire today that “from a market perspective, removing the current stress testing could mitigate some of the impact of higher interest rates. In theory, at least, it should open up a little more capacity for house price growth than is currently looking fairly constrained in the mainstream housing market.”
“This said, a fairly high proportion of recent buyers have worked around the “standard variable rate plus 3 per cent” stress test by locking into five-year fixed rates, meaning it will only preserve or open up additional borrowing capacity for part of the market,” Bowles said.
He stressed: “Lenders will still stress test applicants to reflect where they expect interest rates to be five years from the start of the loan, following the Mortgage Conduct of Business rules.”
“Improved capacity for growth would also be dependent on how far lenders are prepared to push loan to income multiples under responsibly lending rules and caps on what they can lend at high loan to income ratios. It is unlikely to open up the mortgage-credit floodgates.”
Bowles concluded: “It should allow lenders to be slightly more flexible which will come as welcome relief to some would-be-buyers struggling to keep up with current criteria because of significant price growth of the past two years – but saving for a deposit will remain the most significant barrier to home ownership.”