Proposed changes to mortgages could mean buyers can access larger loans
The Bank of England is considering scrapping an affordability rule for mortgages and wants to know what impact this might have on the market. Two recommendations were introduced in 2014 to help guard against a significant increase in household debt which could potentially worsen an economic downturn.
These were a loan-to-income limit and the affordability test, which specifies a “stress interest rate” that lenders must consider when assessing a potential borrower’s ability to pay. pay off a mortgage over time. The loan-income limit is likely to play a more important role than the financial capacity test in guarding against the number of highly indebted households, analysis previously found.
It limits the number of mortgages that can be extended to loan-to-income ratios of 4.5% to 15% or more of a lender’s new mortgages. The Bank is seeking views on the proposal to withdraw the affordability test, in a consultation that asks how lenders and the mortgage market would react if the recommendation were withdrawn.
Sarah Coles, senior personal finance analyst at Hargreaves Lansdown, said the affordability tests “look more and more drastic over time, as they refer to reversion rates – the mortgage rate at which you are transferred to the end of your contract – and insist that you should still be able to pay your mortgage if your rate was three percentage points above your reversion rate”.
“Despite the dramatic fall in mortgage rates in recent years, reversion rates have remained remarkably stable, so to qualify for a cheap mortgage, buyers must prove they can afford a very expensive loan.”
The Bank wants to know what effect the withdrawal of the measure could have on the housing market as a whole and on specific segments. The consultation will close on May 6, after which the responses will be reviewed by the Bank’s Financial Policy Committee.
Based on current evidence, the loan-to-income limit – without the financial capability test, but alongside the broader assessment of financial capability required by Financial Conduct Authority (FCA) rules – should provide an appropriate level of resilience, but in a simpler, more predictable and more proportionate way, according to the consultation document.
The FCA rules set the standards that mortgage lenders must meet when assessing affordability. They relate to the assessment of income, expenditure and, where applicable, the effect of future increases in interest rates. He added that the analysis suggests the affordability test could have caused around 6% of borrowers (about 30,000 a year) to take out smaller mortgages than they would have been able to in its absence. Home prices have hit a series of record highs during the coronavirus pandemic.
Ms Coles continued: “The concern is that this could mean that more people are able to borrow more money, which could leave them vulnerable to overstretching themselves to afford sky-high prices. Any weakness in the property market in coming months could add the risk of negative equity for those who have borrowed significantly more.However, the Bank calculates that a combination of FCA affordability rules and its own rule that limits the number of mortgages with a high loan-to-income ratio will provide sufficient protection.
Myron Jobson, senior personal finance analyst at Interactive Investor, said the risk of “people paying more than they financially chew to buy a property” could be a particular problem among first-time buyers.
He added: “As such, any changes must be approached with great caution.”
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