In its biannual Financial Stability report yesterday, the Financial Policy Committee (FPC) said that it would launch a consultation next year into its affordability test, which stipulates borrowers should be able to afford their mortgage if their mortgage interest rate is three percentage points higher than their reversion rate.
It added that it would maintain its loan to income (LTI) limits for residential mortgages, which states that 15 per cent of the total number of new residential mortgages cannot have a LTI ratio at or greater than 4.5.
The FPC said that the LTI measure in conjunction with the FCA’s affordability test were enough to protect the UK’s financial stability.
The two FPC measures were introduced in 2014 to prevent consumers taking on unaffordable mortgages and to better integrate interest rate changes into affordability calculations.
Trade body reaction
The decision has been welcomed by the Intermediary Mortgage Lenders Association (IMLA), Association of Mortgage Intermediaries (AMI) and the Building Societies Association (BSA).
IMLA’s executive director Kate Davies said that the trade body had long argued that the BoE’s stress testing was a “barrier to homeownership” for many borrowers and it would “welcome a reduction or even removal of the current approach to affordability testing”.
She added: “We understand the importance of protecting borrowers from over-extending themselves – particularly if interest rates were to rise suddenly and excessively. However, the three per cent stress test on top of a lender’s standard variable rate (SVR) means borrowers are often being tested at completely unrealistic rates.”
She continued that the trade body’s most recent report highlighted that the stress test had been a major contributor to low levels of first-time buyers between 2008 and 2020, with an average of 270,000 per year.
Davies said that addressing this barrier would bring lenders’ affordability tests “much more into line” with what borrowers expect and can afford to pay.
This was echoed by AMI’s chairman, Robert Sinclair, who said that it was “encouraging” to see the FPC move forward with relaxing its market restrictions.
He explained: “For those that can raise the deposit required to get on the housing ladder, it has the potential to reduce the other barrier of having to stress repayments at three per cent over the revert to rate.
“This will be good news for first-time buyers in expensive parts of the country and will help those who can afford their rent to potentially reduce their payments for a home of their own.”
Paul Broadhead, head of mortgage and housing policy at the BSA, added: “This measure mainly impacts certain borrowers, such as first-time buyers and those looking to buy in the South East, who can clearly afford a mortgage but are hindered by the requirement to test that they could still pay their mortgage if rates were in the region of six per cent plus.
“Lenders will continue to check that a mortgage is affordable both now and if interest rates increase in line with market expectations.”
Industry reaction
Mortgage brokers and networks also widely welcomed the consultation, adding that if the affordability test was lifted it would give lenders more flexibility and give better outcomes to borrowers.
Rob Clifford, chief commercial officer of MSS, the owner of national mortgage network Stonebridge and SDL Surveying, said: “This move ultimately means that it will be up to lenders to decide how they approach new applicants, handing them the power to determine their own assessments of affordability when offering terms to intermediaries and their prospective borrowers rather than imposing a top-down approach.
“It has the potential to open up the market to more buyers and moves away from the current situation which forced lenders and intermediaries to assume very high go-to rates that were highly unlikely to ever apply to that borrower.”
He added that lenders would have to “remain prudent” amid the possibility of rate rises next year and wider market dynamics but repealing affordability test would allow mortgage lenders “to more appropriately set their risk appetites and to carefully help more borrowers”.
Martijn van der Heijden, chief financial officer at Habito, said that the BoE deciding to review lending limits would be an “improvement of method”.
He explained that “crude income multiples” that are used could be replaced with “more intelligent approaches using borrowers’ true budgets and individual risks”.
He added that new lending limits would accept that absolute levels of debt burden are lower at low interest rates, which is different to when the previous rules were set in 2014.
van der Heijden continued that it would be a better reflection of current house prices in relation to average wages.
He said that affordability had long been an issue for younger borrowers, with house price to income ratio now at 8.6 times income, short of the current cap of lending at 4.5 to five times income. He noted that there was regional variation to this, with the house price to income ratio in London at 11.7 times income, so even larger deposits were needed.
van der Heijden explained: “While this relaxing of lending caps will help ease the burden on buyers for having large deposits, lenders will vary in their offering and will also continue to judge every application individually – so it’s unlikely that six times income will be accessible to everyone.”
He added that long-term or fixed for life mortgages in the UK could be a solution as it doesn’t carry a risk of higher payments with rate rises and could allow lenders and regulators to “be more comfortable with greater levels of borrowing” if customers elect for this type of product.
Habito launched a 40-year fixed rate mortgage earlier this year.
