08 Mar 2022

The Financial Policy Committee (FPC) of the Bank of England has published its consultation on the proposal to withdraw the mortgage “affordability test”, which specifies a stress interest rate for lenders when assessing prospective borrowers’ ability to repay a mortgage. Its removal would contribute to allowing borrowers to take out bigger mortgages, something which could have a potentially seismic impact on the property market.

The test was introduced in 2014 to help 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 other measure was the LTI “flow limit”, which limits the number of mortgages that can be extended at loan to income (LTI) ratios at or greater than 4.5. The affordability tests means 6% of people had to take a smaller mortgage than they otherwise would have, which works out at around 30,000 mortgages a year.

The FPC has regularly reviewed these Recommendations. In its latest review, published in the December 2021 Financial Stability Report, the committee considered a scenario of rapidly rising house prices where, without any policy measures, financial stability risks would increase sharply. The FPC’s analysis found that both of its Recommendations on their own would materially mitigate the increase in risks. But 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.

The FPC judged that the LTI flow limit, without the affordability test Recommendation, but alongside the wider assessment of affordability required by the FCA’s Mortgage Conduct of Business (MCOB) framework, ought to deliver an appropriate level of resilience to the UK financial system, but in a simpler, more predictable and more proportionate way.

According to the Bank, 83% of renters can’t afford a 5% deposit anyway. Of those that can, 6% can raise a deposit, but cannot meet the FCA’s affordability tests and an assumed loan to income cap of 5.5 times salary. Meanwhile, around 1% pass all these tests but could not meet the FPC’s affordability test, which is a significant number but not enough to overwhelm the market.

Therefore, as announced in the December 2021 Financial Stability Report, the Committee decided to maintain the LTI flow limit Recommendation and to consult on withdrawing its affordability test Recommendation.

In the consultation, published today, the FPC is seeking the views of interested parties on the proposal to withdraw the affordability test. The consultation, in particular, asks the following questions:

  • What impact is the affordability test Recommendation currently having on the mortgage market?
  • How would lenders and the mortgage market respond if the Recommendation were withdrawn?
  • What effect withdrawing the Recommendation may have on the housing market as a whole and on particular segments of the market?

Sarah Coles, senior personal finance analyst, Hargreaves Lansdown, commented:

The Bank of England plans to ditch a rule designed to limit massive mortgages. 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 is not fair any more, and that without it, there are still enough protections in place.

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 – and insist you should still be able to afford your mortgage if your rate rose to 3 percentage points above your reversion rate.

Despite mortgage rates dropping dramatically in recent years, reversion rates have remained remarkably sticky, so in order to qualify for a cheap mortgage, buyers need to prove they can afford a really expensive one.”

“The worry is that this 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.

The Bank has also calculated that it’s not going to open the floodgates to huge numbers of new buyers, pushing prices so high that it undoes any benefit from making it easier to borrow.”

The consultation will close on 6 May 2022 after which the responses will be considered by the FPC. In the event of deciding to withdraw its affordability test, the FPC would expect to formally withdraw the affordability test recommendation within 12 months of making the decision.

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