Bank of England confirms withdrawal of mortgage market affordability test

Following its latest review of the mortgage market, the Bank of England's Financial Policy Committee has confirmed that it will withdraw its affordability test Recommendation.

Related topics:  Mortgages,  Regulation
Rozi Jones
20th June 2022
Bank of England BoE
"The 3% stress test on top of a lender’s Standard Variable Rate in fact acted as a barrier to homeownership for many borrowers."

This will come into effect from 1 August 2022.

Introduced in 2014 the test specifies a stress interest rate for lenders when assessing prospective borrowers’ ability to repay a mortgage. The other Recommendation, the loan to income (LTI) ‘flow limit’, which will not be withdrawn, limits the number of mortgages that can be extended to borrowers at LTI ratios at or greater than 4.5.

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 FPC has regularly reviewed these Recommendations. In its latest review, published in December 2021, 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 household indebtedness and the number of highly indebted households in a scenario of rapidly rising house prices.

Therefore it judged that 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 FPC consulted in February 2022 on the proposal to withdraw the affordability test and maintain the LTI flow limit, with the majority of responses supportive of the proposals. Lenders do not need to make any changes as a result, as current affordability assessments ought already to be compliant with the FCA’s MCOB framework.

Gemma Harle, managing director at Quilter Financial Planning, commented: "The timing of today’s announcement that the Bank of England is going to loosen its affordability rules is somewhat baffling and may enrage some who still have the financial crash burned into their memory. With interest rates starting to creep up to meet the damaging impact of inflation and soaring energy and food prices you would think that people's ability to afford their mortgage should really be under the spotlight now. However, this move by the Bank of England may illustrate that the long-term health of the housing market is predicted to be less than rosy, and this change is a means to guard against a real slump in house prices.

"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. 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.

"Ultimately, one of the key strategies the government should adopt to help first-time buyers onto the ladder is simply to build more stock. This has a natural effect of stabilising house prices and bringing them down due to the laws of supply and demand. This will be the only way of really helping the masses get onto the housing ladder."

Mark Harris, chief executive of mortgage broker SPF Private Clients, said: "Scrapping of the affordability test is not as reckless as it may sound.

"The loan-to-income framework remains so there will still be some restrictions in place; it is not turning into a free-for-all on the lending front. Lenders will also still use some form of testing but to their own choosing according to their risk appetite.

"It could have a positive affect on certain borrowers who have been disadvantaged when it comes to getting on the property ladder. For example, first-time buyers who have been affording rents far in excess of actual mortgage payments but have failed affordability assessments regardless.

"The rate environment and expectations have changed significantly since the rules were introduced when borrowers were tested to ensure that mortgage repayments could be met should rates be in the region of 6 to 7 per cent."

Vikki Jefferies, proposition director at Primis, added: “The Financial Policy Committee’s decision to remove the affordability stress test for mortgage applications is very welcome news for the sector. While we understand the importance of protecting borrowers from over-extending themselves, the 3% stress test on top of a lender’s Standard Variable Rate in fact acted as a barrier to homeownership for many borrowers.

“Despite its withdrawal, good controls are still in place. Now, the affordability tests which lenders – quite reasonably – need to carry out before approving loans, will be more in line with what borrowers can expect and afford to pay.

“Indeed, with the Help to Buy scheme coming to an end, this decision will also assist first time buyers, especially in London and the South-East, with stepping onto the housing ladder.”

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