The Bank of England has certainly had a busy time of it of late. As well as increasing interest rates six times since December to try and combat inflation – most recently hiking up the base rate by 50 basis points to 1.75% - it also recently scrapped a key mortgage affordability test.
Let’s take a closer look at what happened and what this could mean for potential homeowners.
What was scrapped?
Taking effect from Monday August 1, the Bank removed a requirement that previously asked borrowers to be able to afford a 3% rise in interest rates before they could be approved for a home loan. This measure was introduced in the aftermath of the global financial crisis (2007-08) to try and make risky borrowing and reckless lending a thing of the past.
First introduced in 2014, the stress test was part of a series of measures implemented to prevent a repeat of the lead-up to the crisis, where questionable lending to people who could ill-afford a mortgage was widespread.
Although some have questioned why such a move is happening now, when the cost-of-living crisis is starting to bite and pay packets are already being squeezed, the Bank insists that this move is not a ‘relaxation of the rules’.
It’s likely that many First Time Buyers or potential homeowners will be delighted by the news, as it could help them to get on the property ladder more easily. However some experts have pointed to the dangers of people again taking out mortgages they can’t afford.
To ease these fears, the Bank has made clear that another rule is remaining the same, whereby most new mortgage lending is limited to a maximum of 4.5 times a borrower’s income. In addition to this, the Financial Conduct Authority sets separate affordability criteria, which the Bank says should deliver the ‘appropriate level of resilience’ to the UK financial system. But, it claims, in a ‘simpler, more predictable and more proportionate way’.
Quite a number of people could benefit from the change, with the BoE suggesting in the past that approximately 6% of mortgage borrowers (equivalent to around 35,000 people) would have been able to obtain a larger home loan if not for the interest rate stress test.
What was the reaction?
The response to the move was mixed, with some welcoming it while others questioned whether the timing was right.
Claire Flynn, a mortgages expert at Money.co.uk, told the Guardian that many would likely view the scrapping of the affordability test as good news given the current cost-of-living crisis and high house prices.
She said it could allow more people to get on the ladder as they can take out ‘larger mortgages’.
“However, borrowers will still need to meet the loan-to-income ratio, which could still prevent some from getting the mortgage they require to buy a home,” she added.
She also told the paper: “There is also a risk that with fewer restrictions, some buyers will take out loans that they are unable to afford.”
Mark Harris, chief executive of mortgage broker SPF Private Clients, argued that scraping the affordability test is not a reckless act.
He told the BBC: “The loan-to-income framework remains so there will still be some restrictions in place; it is not turning into a free-for-all on the lending front. Lenders will also still use some form of testing but to their own choosing according to their risk appetite."
Who could benefit?
There are some borrowers (such as First Time Buyers who have been renting and affording rents easily higher than potential mortgage repayments) who will have previously failed affordability assessments as a result of being unable to prove they could afford their mortgage if interest rates soared by 3%.
According to Mark Harris “The rule change could have a positive effect on borrowers who have been disadvantaged when it comes to getting on the property ladder”.
While there was this barrier to borrowers before, now it’s something that lenders won’t need to check. That said, there remain plenty of checks in place to ensure that borrowers don’t take on mortgages they can’t afford.
Gemma Harle, managing director at Quilter Financial Planning, believes the change in the affordability rules may not be as significant as it sounds as the loan-to-income ‘flow limit’ will remain. And it’s this, she argues, which has much greater impact on people’s ability to borrow.
The ‘flow limit’, as mentioned above, limits the number of mortgages that lenders can grant to borrowers at ratios at or greater than 4.5 times the salary of borrowers. Only in rare cases are higher loan-to-income ratios considered by lenders as a result of this limit.
Following a review of the rules last year, the Bank’s Financial Policy Committee found that the loan-to-income flow limit is likely to play a stronger role than the affordability test in warding against a rise in ‘aggregate household indebtedness’. And, it added, would also guard against ‘the number of highly indebted households in a scenario of rapidly rising house prices’.
Some will argue that the timing is wrong and the change risky – with the potential for people to bite off more they can chew when it comes to buying a home – but others will point to the other checks already in place and the greater opportunities potentially afforded to first time homeowners as reasons why the Bank’s move is the right one.