The BoE introduced two recommendations in 2014, one around loan to income ratio (LTI) which states that 15 per cent of the total number of new residential mortgages should not have a LTI ratio at or greater than 4.5. This applies to lenders whose residential mortgage lending is above £100m per year.
Its affordability test says borrowers should be able to afford their mortgage if their mortgage interest rate is three per cent higher than their reversion rate, in the first-half of next year.
The BoE said in December that it would consider withdrawing the affordability test
Earlier today the BoE’s Financial Policy Committee (FPC) launched a consultation on the mortgage affordability test and said that the LTI limit had a “stronger role” in guarding against an aggregate household indebtedness and the number of highly indebted households.
It added that the affordability test could have limited the borrowing ability of around six per cent of borrowers, or around 30,000 applicants per year.
Kate Davies, executive director at the Intermediary Mortgage Lenders Association (IMLA), said that that the announcement of a consultation to remove the affordability test was “no real surprise to the sector, but is still very welcome”.
She added: “For some time, IMLA has been arguing that the combination of FCA Mortgage Conduct Of Business (MCOB) rules, LTI limits and the three per cent stress test have placed unrealistic demands on borrowers when compared to the rates they have actually been paying, or could expect to pay.
“We are particularly interested in the FPC’s analysis that the LTI flow limit is likely to play a stronger role than the affordability test in guarding against household indebtedness, and we shall be considering each measure’s relative effectiveness carefully as we develop our response to the consultation.”
Robert Sinclair, chief executive of the Association of Mortgage Intermediaries, said that the BoE might be keen to remove the affordability test before the end of Help to Buy, which is due to expire next year.
He explained: “I think that there’s always the continual issue of the deposit, which is the first hurdle you’ve got to get across. For instance, if you’re renting and trying to save at the same time, and add student debt, how many barriers can we put in the way?
“Then there is the next element of affordability hurdle that then becomes a bigger issue particularly for the South and with the loss of Help to Buy, which has been a big help in the market. I think this is this is the change [it] feels comfortable to make in order to try to keep the market moving in the right direction.”
He added: “I think the other part is if you take this off [the affordability test], it might allow others to borrow more. It will have a broader impact across the whole market as opposed to just those who are currently excluded.”
Paul Broadhead, head of mortgage and housing policy at the Building Societies Association, said: “We welcomed the FPC’s intention to withdraw the affordability stress test for new mortgages when it was first announced in December 2021 and still do. This measure primarily impacts borrowers such as first-time buyers and those looking to buy in the South East, who can clearly afford a mortgage.
“Lenders will continue to follow existing rules, including those in MCOB, to check that a mortgage is affordable both now and if interest rates continue to rise in line with market expectations. We are consulting with our members on the specific questions raised in the consultation published today.”
Questions raised for lenders
Nicholas Mendes, mortgage technical manager at John Charcol, said that scrapping the affordability test would be “welcomed by homeowners and broker alike” and that this could be a boost for the market given rising property prices.
“It will be interesting to see how much this will mean, given at the time of rules changing, we are expecting to see inflation continue to increase into 2023, and with multiple base rates rises, lenders could choose to not make any changes. Predicting where rates could be in five years’ time seems almost impossible.”
Mendes added: “Any changes depending on how lenders react will benefit in the short term as buyers have increased affordability muscle in negotiating on a home. Longer term, homeowners would be in the same boat, so broadly speaking no individual homeowner would be better off. What we might see is people bidding higher and/or increasing offers, as a result this risks the same homeowners that would be buying the same properties but at higher values.”
Mendes said that the potential removal raised questions about how lenders might change the way they calculate affordability. He said lenders who use Office of National Statistics (ONS) as the basis for affordability calculations could lead them to review the calculation more regularly and that lenders who trialed this have seen maximum borrowing reduce for homeowners, highlighting a growing concern about those who are currently on shared ownership schemes.
“Based on previous calculators those on the scheme based on potential future affordability modules wouldn’t be able to afford the borrowing that they original took out.”
He added: “Any stress rates changes may mitigate any potential changes if calculations do change as lenders look at ONS stats, it will be interesting to see what lenders do between now and the 17 March in terms of their communication with brokers, and what lenders do after the announcement.”
Mendes added that rising cost of living, increasing energy and fuel costs and Brexit could led lenders to “exercise caution and start to consider other factors to ensure the mortgage remains affordable”.
David Hollingworth, associate director of communications at L&C Mortgages, said: “There’s clearly no desire to remove restraints that could result in a move back to the looser lending standards that were in place in the run up to the financial crisis. However, we do have a belt and braces approach at the moment with the stress rates and LTI limits in place. The stress rate does give some natural space for borrowers to be able to deal with higher rate environments than when they take the initial mortgage.
“However, although stress rates help prepare for rising rates, they keep moving as rates change as well, as is currently the case so it can be a moving target. The FPC seems to suggest that altering the impact on affordability shouldn’t result in so much more leeway that borrowers could be put in harm’s way, so we may find that there’s limited impact and both limits have done their job.”
He added: “If it gives some borrowers, for example first-time buyers, a little bit more flexibility to borrow enough to deal with the pressures that high prices present without throwing the principles of affordability out of the window, it might just help a few more borrowers get the mortgage they need.”