The Bank of England has ditched a longstanding recommendation that lenders assess homebuyers' ability to pay back a more expensive mortgage than the one they're getting. Since at least 2017, the Bank of England has issued a formal recommendation to lenders that they assess prospective borrowers' ability to keep up their mortgage repayments even if their interest rate were to increase by three points within five years.
That means, for example, that your bank must be satisfied that you would still be able to pay off your mortgage if your interest rate went from three per cent to six per cent. That recommendation will no longer apply from August 1, 2022.
Lenders will still need to carry out affordability tests as they are bound by the Financial Conduct Authority's rules, which will remain in place. And lenders can also continue carrying out these interest rate-based "stress tests" if they wish to; they just will no longer be forced to.
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The Bank of England's financial policy committee argued in its latest announcement that it has had concerns for a while about how the stress test is implemented. It said: "In particular, the stress rate required by the test has remained broadly static, reflecting stickiness in reversion rates despite past falls in average quoted mortgage rates."
It concluded that another test that must also be applied to all prospective borrowers, the loan to income (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 when house prices rise rapidly. In addition, analysis suggests that the additional insurance provided by the affordability test is small.
"A framework without the FPC’s affordability test recommendation would therefore be simpler and more predictable. It would also reduce the impact on a small proportion of borrowers, while the wider assessment of affordability required by the FCA’s MCOB responsible lending rules would remain as an appropriate affordability check."
The LTI limit, which will remain in place, limits the number of mortgages that can be extended to borrowers at LTI ratios at or greater than 4.5/ This means you will have less choice if you are attempting to borrow more than 4.5 times your salary.
According to data from Rightmove released on Monday, the average asking price across Britain stands at £368,614 – with June marking the fifth month in a row that it has hit a record high. The average salary for a full-time employee, on the other hand, is £31,772 - meaning someone on the average salary looking to buy an average property has an LTI ratio of 11.6.
Gemma Harle, managing director at Quilter Financial Planning, said: “While it is potentially bad timing for the announcement, the change in the affordability rules may not be as significant as it sounds as the loan-to-income (LTI) ‘flow limit’ will not be withdrawn, which has much greater impact on people’s ability to borrow.
“Although the shift in rules is one of the many attempts to help first-time buyers get their foot on the ladder, it may end up having the opposite effect. One of the main drivers behind ‘generation rent’ is the fact that house prices have massively outstripped wage growth. Due to high house prices, first-time buyers also need very sizable deposits and in the current fiscal environment saving this type of money will be very difficult due to increasing rents and the cost of living.
“On top of this, inflation will be eating away at any other savings they have sitting in cash. House prices have become further and further out of reach for prospective buyers and this change in the affordability rules could perpetuate unsustainable further growth as it steps up demand in a market already suffering with limited stock."
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