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Bank of England’s mortgage affordability stress test to go

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  • 28/02/2022
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Borrowers may be able to take out larger mortgages as the Bank of England consults on removing the affordability test amid concerns and uncertainty about its role in the future.

Currently, borrowers are subjected to two tests when taking out mortgages, introduced by the Financial Policy Committee (FPC) in 2014 to “guard against a loosening in mortgage underwriting standards” which could lead to an increase in household debt.

The Bank of England has launched a consultation to withdraw the affordability test while keeping the loan to income flow (LTI) limit as it “ought to deliver an appropriate level of resilience to the UK financial system, but in a simpler, more predictable and more proportionate way.”

 

Borrower and lender tests

One test is the LTI ratio which refers to how much the mortgage applicant can borrow relative to their annual income. Typically, this stands at 4.5 per cent, though lenders can extend this LTI ratio to 15 per cent of new mortgage lending.

The second is the affordability test which specifies a stress interest rate for lenders when assessing prospective borrowers’ ability to repay.

This tests whether they could still afford their mortgages if at any point over the first five years of the loan, the mortgage rate was to be three percentage points higher than the reversion rate.

The Bank of England has launched a consultation on withdrawing the FPCs affordability test, while it maintains the LTI recommendation.

It said the LTI 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 when house prices rise rapidly”.

 

Concerns and uncertainty

The move comes as the Bank revealed the affordability test could have caused around six per cent of borrowers – roughly 30,000 per year – to take out smaller mortgages than they would have been able to in the absence of the test. Most of those constrained by the affordability test took out mortgages with LTI ratios of under 4.5.

Further, its analysis revealed that 83 per cent of renters currently lack the savings to raise a five per cent deposit themselves. A further six per cent would be able to raise a deposit, but are not currently able to meet affordability assessments.

The Bank said it had “concerns” with how the affordability test has operated.

It said: “The stress rate encapsulated in the test has remained broadly static, reflecting stickiness in reversion rates despite the fall in average quoted mortgage rates. This demonstrates that there is considerable uncertainty about how the stress rate encapsulated in the affordability test might move in future, and in turn about the effect the test could have.”

However, while the absence of the FPC’s affordability test would make things “simpler, more predictable and reduce the impact on a small proportion of borrowers”, the Bank said responsible lending rules in place under the Financial Conduct Authority’s Mortgage Conduct of Business (MCOB) “would remain as an appropriate affordability check”.

It stated: “A lender must also assume that interest rates rise by a minimum of 100 basis points during the first five years of the mortgage. In the event that the FPC decides to withdraw its affordability test recommendation, MCOB rules on responsible lending would continue to apply. The only change would be that, for lenders considering the effect of future interest rate rises, there would be no prevailing FPC recommendation on interest rate stress tests to have regard to.”

The consultation closes on 6 May 2022. If a decision is taken to withdraw the affordability test, it would be expected to take effect within 12 months.

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