The Bank of England will scrap a key mortgage affordability policy to prevent people from becoming financially overwhelmed.
After its latest review of the mortgage market, the central bank’s Fiscal Policy Committee has confirmed that the affordability stress test, in which lenders pit borrowers’ finances against their high default variable interest rates plus 3 percent, will end on August 1.
The test is part of recommendations put in place in the wake of the 2014 financial crisis to protect against easing of mortgage lending standards and a significant rise in household debt.
The stress test meant borrowers had to demonstrate that they could still afford their mortgage payments if their mortgage rate went up 3 percent above their lender’s standard variable rate.
The Fiscal Policy Committee has confirmed that it will withdraw its affordability test recommendation. This will come into effect on August 1, 2022.
Since most borrowers already have fixed rates and standard variable rates higher than this, a 3 percent increase to test borrowers’ finances has been criticized as unrealistic.
SVRs are the default rate people switch to when firm or other deals end, and they’re far more expensive. However, most borrowers switch to a new mortgage deal and don’t end up with a standard variable rate.
The average SVR has hit a 13-year high of 4.91 percent, according to Moneyfacts, after rising 0.51 percent since December 2021.
Based on today’s average, the elimination of the affordability stress test means that a typical borrower is no longer judged on whether they could hypothetically afford an interest rate 3 percentage points above 4.91%.
The decision to scrap this test could therefore provide some breathing space for some borrowers, especially given that higher mortgage rates and the cost of living are already impacting affordability and creditworthiness.
Lenders are increasingly considering higher bills when assessing what borrowers can pay on their mortgage each month.
Santander, for example, has already incorporated increased social security, household spending and dividend tax rates into its affordability calculations. Others are expected to do the same.
Chris Sykes, Technical Director at Mortgage Brokerage, Private Finance, said: “Recently, many lenders have changed their affordability calculators due to both the rising cost of living and the rising interest rates that we are seeing.
“This morning’s press release detailing that they are withdrawing their stress test recommendations is great news for borrowers who have always been tighter on affordability and constrains their borrowing power with each change to the affordability calculators.”
However, while the stress test is being phased out, the other recommendation from 2014, the loan-to-income flow limit, will continue.
The loan-to-income ratio is the multiple at which banks lend based on a person’s annual salary.
This means banks will continue to limit the number of mortgages they can offer if someone is borrowing more than 4.5 times their salary.
The credit-to-income flow limit was considered more important than the affordability test to protect against an increase in overall household debt in an environment of rapidly rising house prices.
What does the abolition of the stress test mean?
The decision has sparked fears it could lead to irresponsible lending and allow people to borrow beyond their means.
However, the impact may not be as great as some fear. The affordability stress test has resulted in just 6 per cent of people taking out a smaller mortgage than they would otherwise have, according to the Bank of England. This equates to around 30,000 mortgages a year.
Mortgage brokers were also quick to downplay concerns that it might mean a return to the irresponsible lending practices that preceded the 2007-08 crash.
Mark Harris, managing director of mortgage broker SPF Private Clients, says: “Abolishing the affordability test is not as reckless as it might sound.
“The credit-to-income framework remains in place, so there will still be some restrictions; it’s not evolving into a free-for-all on the lending front.
“Lenders will continue to use some form of testing, but at their own discretion according to their risk appetite.”
A slight relief? Higher mortgage rates and the cost of living are already beginning to impact affordability and creditworthiness.
Additionally, these affordability checks have also been blamed for discouraging some first-time buyers from 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 as they climb the real estate ladder.
“For example, first-time buyers who can afford rents well in excess of actual mortgage payments but still failed the affordability assessment.”
Similarly, given the rapid rise in mortgage rates over the past few months and the fact that the loan-to-income measures are still in place, according to Chris Sykes, this will not open up.
“Just because the recommendations change doesn’t mean banks automatically change their perspective,” Sykes said, “they still have a duty of care, they need to be seen as lending responsibly, and they also have their own internal.” Risk committees that would need to approve changes.
‘What this will enable is additional innovation by lenders.
“Perhaps it could lead to lower stress rates for those who need it most, on low incomes but with perfect credit and years of experience paying their rent.
“We already often see lower mortgage lending rates as long as no additional borrowing is taken out and they have a clean credit record.
“This could help refinance additional people whose incomes have been reduced due to, for example, Covid changing their working arrangements.
“The key here is that the loan-to-income measures are still in place, so there are still extensive measures in place to protect borrowers and lenders.”
Could we see lenders easing loan-to-income limits?
There is currently a regulatory requirement that lenders only offer a certain number of loans above 4.5 times annual income.
Typically, up to a maximum of 10 percent of a lender’s loan book can be reserved for those who borrow more than 4.5 times their annual income.
The latest Halifax housing data showed house prices rose again in May, with the average house price hitting another record high of £289,099.
Meanwhile, regular salaries fell 2.2 percent from February to April, according to the ONS – adjusted for inflation.
The average house price is now worth almost nine times the median income.
Lenders can only offer a certain number of loans that exceed 4.5 times annual income, but average house prices are almost 9 times average annual income.
This means that many first-time buyers and movers have had to stretch to the highest credit-to-income ratio possible to afford the type of property they want to live in.
Sykes said: “Purchasing power has declined, particularly in the last two years, and buyers can no longer afford the same size or number of bedrooms that they used to be able to afford.
“With that in mind, we wonder if we can see some of the lenders starting to hit those regulatory limits?
“We have seen more flexibility from lenders to help borrowers in recent years during periods of strong house price increases, but we are beginning to wonder how much longer this can be sustained under current rules unless those rules are adjusted, to reflect this current climate.
“With rising home prices and affordability concerns, there may need to be more flexibility around this regulation and increase the percentage of loans above 4.5 times income to get more people up the housing ladder.”
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Bank of England to scrap mortgage affordability test
Source link Bank of England to scrap mortgage affordability test