First-time buyers may get a boost from this week’s announcement that the Bank of England will no longer expect lenders to check if they can afford mortgage payments at higher interest rates – but experts do not expect it to lead to a mortgage free-for-all.
From 1 August, banks and building societies will no longer be required to stress-test a borrowers’ finances with the mortgage market affordability test when working out how much to lend.
The test meant checking that a borrower could still afford their loan at the end of any short-term special offer period in the event of rising interest rates. Lenders worked this out using the “revert to” rate – the standard variable rate or tracker rate that borrowers would move on to, plus three percentage points.
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As an example, a borrower taking out a two-year fixed-rate mortgage at 2.2% with a revert to rate of 4% would need to show they could afford the monthly repayments on a rate of 7%.
The rules were introduced in the aftermath of the 2007-2008 financial crash, which followed years of unrestrained lending. In the early 2000s, mortgages were available at more than 100% of a property’s price, could be taken out easily on an interest-only basis and were often granted without any proof of income.
However, some within the industry had complained the affordability test was too onerous and prevented some borrowers, who could afford a mortgage, being given one.
Scrapping the test may help would-be buyers who have been refused mortgages that have lower repayments than the sum they pay in rent each month. A consultation by the Bank found that in order to qualify for home loans people were taking mortgages over longer terms, or on longer-term fixed-rates, which meant paying more overall.
“The removal of the mortgage market affordability test is good news, particularly for first-time buyers who should be able to borrow more,” said Mark Harris, the chief executive of the mortgage broker SPF Private Clients. “Although critics will argue that it will only serve to stoke a hot market and making more credit available will send house prices soaring again.
“However, there will still be restrictions in place and it won’t be a lending free-for-all.”
Neal Hudson, a housing market analyst at the consultancy BuiltPlace, agrees that removing the three-percentage-point stress test “doesn’t mean that mortgage lending will become free and easy like it was in 2007”.
Banks and building societies are still restricted on how much lending they can do above 4.5 times salary – this stops them agreeing lots of big mortgages and this has been having more of an impact on first-time buyers than the affordability tests.
The Financial Conduct Authority still insists on stress tests. Under its rules, lenders have to check affordability at one percentage point above the rate borrowers will move on to. “It’s lower but lenders do have to take into account market expectations of where rates will be,” Hudson said.
With interest rates heading upwards, and some suggesting the Bank base rate could hit 3% next year, it is unclear how cautious lenders will be. The Bank says it will be up to individual lenders to decide whether they want to make any changes to their lending practices and, if they do, when they are introduced.
The trade body for banks, UK Finance, says the rule change will make it possible “for firms to review mortgage applications in a more tailored way, while maintaining the underwriting standards required by the FCA and ensuring mortgages are affordable in the long-term”.
Lenders are already allowed to offer fixed-rates of at least five years without applying the Bank’s stress tests but most still did them anyway, which has affected some borrowers’ chances of getting a mortgage. It is likely they will drop them now.
However, mortgage rates have been rising in recent weeks. Those increases, combined with other rising living costs, mean many experts are not expecting the rule change to have much impact on borrowing in the short-term.
“By the time the rules come through, your ability to afford a mortgage will probably be more constrained than now, given the speed at which mortgage rates are moving at the moment,” Hudson said.
“By the time we get to the autumn, if you’re looking to buy, you will be facing a higher mortgage rate. The market is doing some of the work to counteract the removal of the three-percentage-point test.”
Dan Wilson Craw, the deputy director of the campaign group Generation Rent, said: “Barely a week goes by without seeing a viral tweet by someone who is paying £1,000 in rent but has been told by the bank that they can’t afford a £600 mortgage. It’s a significant part of the housing crisis and is partially caused by this requirement on lenders to test affordability on an assumption that future interest rates will be much higher than they are today.
“Giving lenders more discretion over their tests may help, though they will still be required to take account of future interest rates. Fundamentally, the problem is that property prices have been allowed to get too expensive, leading to this painful trade-off between requiring large savings or dangerous levels of debt to buy a home.”