The Bank of England has recently announced they are going to scrap the affordability stress tests that were put in place following a review of the mortgage market after the 2008 credit crunch. The timing of this announcement is very strange for a number of reasons, with many feeling that while the country is in crisis over the cost of living, long-term affordability should be the current top priority.
What is the affordability stress test?
Lenders and Financial Advisors are required to demonstrate that a customer can afford the lending they are offering them, both at the current rate and on the lender’s standard variable rate (the rate it reverts to after the deal ends) plus 3%. This can often be more than double the interest rate that a customer is actually paying on the mortgage and the probability of someone being forced onto the lender’s standard variable rate is low. Both the adviser and the lender have a duty of care to inform borrowers of when their current deal ends and make sure that the customer is on the best deal that’s available to them at that time.
What impact will it have on my ability to get a mortgage?
We will not know for sure until we get more detail on how lenders are going to implement these changes, but I suspect that ending affordability stress tests will not have a huge impact.
All lenders use an affordability calculator to assess how much someone can borrow. This usually factors in the customer’s income and expenditure, but also factors in general costs of living. Many lenders use the Office of National Statistics (ONS) figures to estimate the cost of living. These figures are regularly updated and adjusted and so an affordability calculation now will take these higher costs of living into account.
The main driver of affordability however is something called the “loan to income flow limit” which is essentially a cap on how much someone can borrow against their income. Many lenders cap this at 4.5x income but some go up to 5x and higher under certain circumstances. Lenders must report how much of their lending is at these higher levels so that the Bank of England and the Financial Conduct Authority can keep track of this higher-risk lending. This is staying in place and tends to be a much bigger indicator of what lenders will lend over the affordability stress test.
This is a bit of a chicken and egg problem. Greater affordability can push house prices up, meaning that we need to increase affordability, in turn, to make sure people can afford homes, which in turn can increase prices, and so on. This can cause spiralling house prices and potentially create a bubble at risk of bursting. These affordability restrictions were brought in because of that situation happening before Whilst the economic challenges we’re facing now are very different, we need to remember the lessons from the past.