The Bank of England will axe a key mortgage affordability guideline designed to prevent people from financially overstretching.
Following its latest review of the mortgage market, the central bank’s Financial Policy Committee has confirmed that from 1 August the affordability stress test making lenders pit borrowers’ finances against their high standard variable rates plus 3 per cent will be withdrawn.
The test is part of recommendations introduced in 2014 in the aftermath of the financial crisis to guard against a loosening in mortgage underwriting standards and a material increase in household debt.
The stress test means borrowers have had to prove they could still afford their mortgage repayments if their mortgage rate was to increase to 3 per cent above their lender’s standard variable rate.
The Financial Policy Committee has confirmed that it will withdraw its affordability test Recommendation. This will come into effect from 1 August 2022.
With most borrowers on fixed rates and stanadard variable rates already higher than these, adding 3 per cent to them to test borrowers’ finances has been criticised as unrealistic.
SVRs are the default rate that people move to when fixed or other deals end and are far more expensive, Albeit, most borrowers switch to a new mortgage deal and don’t end up on a standard variable rate.
The average SVR has reached a 13-year high of 4.91 per cent, according to Moneyfacts, following a rise of 0.51 per cent since December 2021.
Based on the today’s average, the removal of the affordability stress test means that a typical borrower will no longer be assessed on whether they could hypothetically afford an interest rate of 3 percentage points above 4.91 per cent.
The decision to remove this test may therefore offer respite to some borrowers, particularly given that higher mortgage rates and the cost of living is already beginning to have ramifications for affordability and what people can borrow.
Lenders are increasingly taking higher bills into account when assessing what borrowers can afford to pay each month toward their mortgage.
Santander, for example, has already factored increased national insurance, household expenditure and dividend income tax rates into its affordability calculations. Others are expected to do the same.
Chris Sykes, technical director at mortgage brokerage, Private Finance said: ‘Recently we have seen many lenders altering their affordability calculators, both due to the rising costs of living as well as the rising interest rates that we are seeing.
‘This mornings news release detailing they are withdrawing their stress testing recommendations is great news for borrowers that were becoming increasingly tight on affordability and it is limiting their borrowing power with each change to affordability calculators.’
However, whilst the stress test will be scrapped, the other recommendation made in 2014, the loan-to-income ‘flow limit,’ will continue.
The loan-to-income-ratio is the multiple at which banks will lend based on someone’s annual salary.
This means banks will continue to place a limit on the number of mortgages they can offer where someone is borrowing more than 4.5 times their salary.
The loan-to-income flow limit was deemed more important than the affordability test in guarding against an increase in overall household indebtedness in an environment of rapidly rising house prices.
What will the removal of the stress test mean?
The decision has raised fears that it could lead to irresponsible lending and enable people to borrow beyond their means.
However, the impact may not be as great as some fear. The affordability stress test has caused just 6 per cent of people to take a smaller mortgage than they otherwise might have, according to the Bank of England. This equates to roughly 30,000 mortgages a year.
Mortgage brokers have also been quick to downplay concerns of this marking a return towards the irresponsible lending practices in the run up to 2007/08 crash.
Mark Harris, chief executive of mortgage broker SPF Private Clients, says: ‘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.’
Some light relief? Higher mortgage rates and the cost of living is already beginning to have ramifications for affordability and what people can borrow.
Furthermore, these affordability checks have also been blamed for stopping some first-time buyers taking out mortgages that would be cheaper than their rent.
Harris adds: ‘It could have a positive impact 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.’
Similarly, according to Chris Sykes, this won’t be a case of the flood gates opening given how fast mortgage rates have been rising over recent months and the fact that the loan-to-income measures are still in place.
‘Just because the recommendations change it doesn’t mean that banks will automatically change the way they look at things,’ said Sykes, ‘they still have a duty of care, they have to be seen to be lending responsibly and they also have their own internal risk committees that that would need to approve any changes.
‘What this will allow, is for additional innovation by lenders.
‘Perhaps it could inspire some lower stress rates for those that need it most with low income but with perfect credit and years of experience paying their rent.
‘We already often see lower stress rates for remortgages, as long as no additional borrowing is being taken and they have a clean credit record.
‘This could help additional people remortgaging whose incomes have reduced due to Covid changing their working circumstances for example.
‘The key here is that the Loan-to-income measures are still in place, so there are still large measures to protect borrowers and lenders.’
Could we see lenders relax the loan-to-income limits?
At present, the regulatory requirement is that lenders only offer a certain number of loans over 4.5 times annual income.
Typically up to a maximum of 10 per cent a lender’s loan book can be reserved for those borrowing over 4.5 times their annual income.
The latest housing data from Halifax showed house prices rise again in May with the average house price reaching another record of £289,099.
Meanwhile, regular pay fell by 2.2 per cent from February to April – adjusted for inflation – according to the ONS.
The average house price is now worth almost nine times the average income.
Lenders can only offer a certain number of loans over 4.5 times annual income, but average house prices are almost 9x the average annual income.
This is meaning that many first-time buyers and home movers, have been needing to stretch themselves to the highest loan-to-income ratio possible in order to afford the type of property they would like to live in.
Sykes said: ‘Buying power has reduced especially over the last two years and buyers cannot afford the same sized property or number of bedrooms they once could.
‘With this in mind we wonder, could we see a proportion of lenders starting to reach these regulatory limits?
‘We have seen more flexibility from lenders over the last few years during periods of large house price growth to help borrowers, however we are starting to question how much longer can this be sustained considering the current rules, unless these regulations are flexed to reflect the current climate.
‘With house prices soaring and affordability concerns, maybe there needs to be more flexibility regarding this regulation and for the percentage of loans above the 4.5 times income to increase in order for more people to get onto the housing ladder.’
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