In 2014, the Financial Policy Committee (FPC) began subjecting borrowers to two tests when taking out mortgages. These were meant to “guard against a loosening in mortgage underwriting standards,” which, in turn, could lead to a material increase in aggregate household debt.
The loan to income (LTI) flow limit restricted the number of mortgages there could be (15% of new residential mortgages) where the LTI ratio – how much the mortgage applicant could borrow relative to their annual income – was higher than 4.5.
The affordability test specified a stress interest rate for lenders to assess a borrower’s ability to repay a mortgage, requiring a borrower to be able to afford their mortgage if the interest rate went three percentage points higher than the reversion rate.
Since the introduction of these measures, the FPC reported, mortgage debt to income “has been broadly stable.”
Still, the Bank of England has launched a consultation on withdrawing the affordability test while maintaining the LTI recommendation. It wants to know what effect withdrawing the affordability test would have on lenders and the housing market.
According to the bank, the LTI limit was simpler, more predictable, and likely to play a stronger role than the affordability test in guarding against an increase in aggregate household indebtedness.
Hargreaves Lansdown senior personal finance analyst Sarah Coles remarked: “Letting people borrow more money looks like a risky move at a time when house prices are sky-high and the outlook is uncertain. But the Bank is convinced the extra test isn’t fair anymore and that, without it, there are still enough protections in place.”
The Bank of England had previously pointed out that responsible lending rules under the Financial Conduct Authority’s Mortgage Conduct of Business (MCOB) would continue to apply as an appropriate affordability check.
“The FPC’s affordability tests have seemed increasingly draconian over time because they refer to reversion rates – the mortgage rate you’re moved to at the end of your deal….
“Despite mortgage rates dropping dramatically in recent years, reversion rates have remained remarkably sticky,” Coles said. “So, in order to qualify for a cheap mortgage, buyers need to prove they can afford a really expensive one.
“The worry is that [withdrawing the affordability test] could mean more people able to borrow more money, which could make them vulnerable to over-stretching themselves to afford sky-high prices.
“Any weakness in the property market in the coming months could add the risk of negative equity for those who have borrowed much more. However, the Bank calculates that a combination of the FCA’s affordability rules and its own rule that limits the number of mortgages with a high loan-to-income will offer enough protection,” Coles said.
The consultation closes on May 06, 2022.
