Despite the scrapping of the Bank of England’s lender stress test for mortgage borrowers, brokers believe the right affordability rules are in place to avoid a slew of mortgage defaults as the cost of living crisis bites.
Some in the industry said they were “baffled” when the central bank’s Financial Policy Committee last month ditched its 2014 stress test ruling, which required lenders to apply a stress interest rate of 3% when assessing prospective borrowers’ mortgage affordability.
But many others say the bank’s 3% stress test had become irrelevant in the current market as the body had become assured that lenders had tighter measures in place to assess loan quality and protect the wider financial market since the 2008 financial crisis.
The FPC said its existing loan-to-income limit, also introduced in 2014, which restricts the number of new mortgages that can be extended to borrowers at LTI ratios at or greater than 4.5 times salary to 15% of a lender’s new mortgage lending in any rolling four-quarter period was a tougher affordability measure.
It added that this taken together with the Financial Conduct Authority’s existing Mortgage Conduct of Business rules, in place since 2003, would safeguard loan quality across the industry.
Xpress Mortgages mortgage & protection advisor Carmen Green says: “It is now standard practice for mortgage lenders to adjust their background affordability assessments in line with changes to mortgage interest rates and living costs, along with their obligations to meet the regulators expectations for ‘responsible lending,’ they carry out extensive risk assessments where various factors are taken into account, not just the affordability stress test.”
Coreco managing director Andrew Montlake adds: “The reality is that the stress test will not be missed at all for several reasons. First of all many lenders seem to have actually left a similar level of additional tests in place for now, choosing not to change things given the recent rises in rates.
“Lenders will be looking at their affordability as a whole and the recent rises in energy costs will be taken into account and mean that for many there will be no difference anyway.
“Rate rises will get to a new norm, and it seems harsh to have had to start stress-testing borrowers at levels of 9 or 10%, so dispensing with the test seemed the sensible move. Lenders still have to adhere to a 1% stress test and many borrowers are still looking at five-year fixes and beyond in any case, so the effect of the removal of these tests will overall be muted at best.”
Vantage Finance managing director Lucy Barrett says the 3% stress test was a useful stability control when it was introduced almost a decade ago, but the focus should now be placed on tighter underwriting.
Barrett says: “The 3% interest stress test in hindsight was a very helpful control introduced, despite alienating some borrowers who you might argue could afford a mortgage and met other affordability requirements it will hopefully have saved more than those who fell into that category in a rising interest rate market.
“After interest rates fell to all-time lows and stayed there it became the new accepted normal level despite the reality that one day interest rates would likely return to higher levels again.
“While the speed at which interest rates have risen may have caught us off guard the stress rate served its purpose and the bigger focus should be on affordability underwriting to ensure borrowers can withstand the rising energy costs.”
L&C Mortgages associate director, communications David Hollingworth adds: “The Bank of England’s stress rate removal may have been viewed as unusual timing but came after reviewing what had been a belt and braces approach in combination with the LTI limits. It was judged that the LTI limit was effective in ensuring that standards would not be loosened too far and that the Bank stress test could be removed.
“Lenders will be considering how the outlook could affect borrower affordability and are unlikely to have made any rapid shift following the removal of the Bank stress test. However, it will hopefully give them a little more flexibility as they deal with the rising cost of living which will inevitably weigh on homeowners’ affordability.”
Most lenders agree that scrapping the 3% test, but keeping LTI limits and Mortgage Conduct of Business rules, is the best way to maintain wider financial stability.
In May, UK Finance’s response to the FPC’s consultation paper on removing the stress test said: “The majority of our members support the FPC’s proposals to withdraw its affordability recommendation, whilst maintaining the LTI recommendation but recognise that there could be some risks associated with its removal during a period of high inflation.
“However a few disagree with its removal, believing that the deteriorating economic environment means it would not be appropriate to remove the recommendation now.
“The less customer-centric, more structural LTI test is, in our opinion, the appropriate test for the more macroprudential focus of the FPC, as it plays a more important role in limiting aggregate household over-indebtedness.”
The central bank has raised interest rates six times since December to 1.75%, to combat rising prices led by energy and food.
Inflation has risen steadily over this period, and although it eased slightly in August, falling to an annual rate of 9.9% from 10.1% in July, the pace of price rises remains close to the highest rate in 40 years.
Falling petrol and diesel prices accounted for lower overall inflation, according to the Office for National Statistics. But many economists warn the inflation rate is likely to continue to rise, as the cost of food, clothing and services continue to climb. The Bank forecasts the cost of living will hit 13% by the end of the year.
House prices in the UK eased slightly to 11.5% in the year to August, Halifax says, putting the average property price at £294,260. Down from 11.8% annual growth in July.
However, the mortgage industry is in broad agreement that the right affordability measures are in place to resist the cold snap this winter.
