As a result of the Bank of England’s elimination of an affordability test, restrictions on mortgage borrowing have been relaxed.
The “stress test” required lenders to determine whether potential borrowers could manage if interest rates rose by up to 3 percentage points.
Eliminating the requirement may make it easier for some potential borrowers to obtain loans, such as self-employed or freelance workers.
However, other regulations such as high loan-to-income limitations will not make it easier for the majority of individuals to obtain a mortgage.
The withdrawal of the affordability test, which was announced in June, took effect on Monday.
Mark Harris, CEO of mortgage broker SPF Private Clients, stated, “Removing the affordability test is not as irresponsible as it may sound.”
“The loan-to-income ratio framework remains, so there will still be some constraints in place; lending is not becoming a free-for-all.”
Lenders will continue to use some type of testing, but they will do it based on their risk tolerance.
In other words, there will be no immediate effect on borrowers because lenders would not be required to change the way they evaluate loans.
Nevertheless, some may alter their own rules in the future.
Mark Yallop, chairman of the Financial Markets Standards Board, stated that while the modification might make it “somewhat easier” for some borrowers to obtain a mortgage, he did not believe it would have a significant impact.
“The capacity of borrowers to afford a down payment poses the greatest barrier to new mortgages,” he noted.
What was the discarded exam?
The mortgage affordability test was implemented in 2014 as part of a comprehensive effort to tighten the mortgage industry and prevent a repeat of the miss-selling debacle that contributed to the 2008 financial crisis.
The rule was implemented to prevent borrowers from posing a threat to the financial stability of lenders by incurring debt they might not be able to repay.
Lenders had to determine not only whether consumers could afford a mortgage at the provided rate, but also how they would fare if interest rates increased by 3 percentage points.
Even if they could have afforded a mortgage at the current interest rate, borrowers who could not demonstrate they could handle such a contingency may have been denied a loan on this basis.
Consequently, the test was perceived by some as an obstacle for some borrowers.
Mr. Harris stated that the regulation change could benefit borrowers who have been disadvantaged when it comes to gaining access to the housing ladder.
For instance, some prospective first-time buyers who have been able to comfortably afford rents substantially higher than future mortgage payments have failed affordability evaluations.
What remaining checks do borrowers have?
There are important safeguards in place to ensure that borrowers do not take out loans they cannot afford.
The primary one is a loan-to-income “flow limit” that restricts the number of mortgages that lenders can give to customers with loan-to-income ratios of 4.5 or above.
Due to the constraint, it is extremely uncommon for a lender to contemplate a greater loan-to-income ratio.
The Bank of England’s Financial Policy Committee determined, following a review of the rules in 2021, that “the LTI flow limit is likely to play a greater role than the affordability test in preventing an increase in aggregate household indebtedness and the number of highly indebted households in a scenario of rapidly rising house prices.”
The loan-to-income ‘flow restriction’ will not be removed, which will have a considerably larger impact on people’s ability to borrow, according to Gemma Harle, managing director at Quilter Financial Planning.
The FCA’s Mortgage Conduct of Business responsible lending regulations also mandate a comprehensive affordability analysis.
