The Bank of England has decided to ditch its affordability stress tests from August, where mortgage lenders were told they have to check whether applicants can afford to keep paying their loan at a higher interest rate.
Stress tests were introduced in 2014 in a bid to prevent another mortgage-induced crisis that we saw in the US, and to a lesser extent in the UK, that sparked and stoked the flames of the global financial crisis.
The Bank decided that other rules were sufficient to keep lending safe, as loan-to-income rules specify that less than 15% of a lender’s mortgage book can have a loan-to-income ratio above 4.5%.
The Financial Conduct Authority’s Mortgage Conduct of Business responsible lending rules are still in place, which state that lenders need to take into account market expectations around the effect of future interest rate rises.
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.”
However Gemma Harle, managing director at Quilter Financial Planning, labelled this a ‘baffling decision’, given that we are in an environment where the base rate is steadily increasing, as the latest hike took it to 1.25% last week.
She said: “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.”
The Bank of England announced the decision on its website following a meeting with the Financial Policy Committee.
It said: “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 the December 2021 Financial Stability Report, 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 aggregate household indebtedness and the number of highly indebted households in a scenario of rapidly rising house prices.
“Therefore 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.”