Bank of England Withdraws Mortgage Affordability Stress Test

 How will the withdrawal of the Bank of England affordability stress test impact the mortgage market?

 

What are the Bank of England affordability checks?

 

Following the 2007/08 financial crisis, the Financial Services Authority carried out the Mortgage Market Review, introducing new mortgage affordability checks that came into effect in April 2014. These are:

  • The Loan-to-Income (LTI) flow limit – mortgages with a LTI ratio of 4.5 or above can make up a maximum of 15% of a lender’s new mortgage lending
  • The affordability stress test - this assesses whether mortgage applicants would be able to keep up with repayments in the event of a 3% increase in the reversion rate (the rate a mortgage reverts to after the fixed period ends)

Following a consultation on the removal of the test, the Financial Planning Committee (FPC) will withdraw the affordability stress test from 1 August 2022.

 

What impact has it had so far?

 

The actual numbers on how many mortgage applicants have fallen at the affordability stress test hurdle are unknown. The consultation on the removal of the test found that around 6% of borrowers, around 30,000 a year, were forced to take out smaller mortgages due to the affordability test.

Analysis in the December 2021 Financial Stability Review revealed that the majority of renters have been limited by deposit size and not the affordability stress test. It found that just 1% of renters were able to raise a 5% deposit for house purchase, and meet the lenders’ LTI cap, but weren’t able to pass the FPC affordability stress test.

Why is it being removed?

 

The above consultation paper found that the LTI flow limit has had a far more significant role than the affordability stress test in shielding the market from high numbers of indebted households. It also found that the affordability test provided minimal additional insurance beyond the LTI flow limit.

What impact will its removal have?

 

In the current climate of high inflation and rising interest rates, the removal of the stress test will help some buyers maintain access to the mortgage market. Monthly mortgage repayments are increasing as the Bank of England base rate is at its highest since the financial crisis and since the stress test has been in place.

According to Moneyfacts the average Standard Variable Rate (SVR) reached 4.91% in June 2022. This is the highest it has been since February 2009. If the stress test had remained in place, buyers would have had to have been able to afford £1,723* in monthly repayments on a SVR of 7.91%. From August, they will only need to be able to afford £1,304 in monthly repayments on the same mortgage.

Analysis carried out in the above consultation would suggest that the removal of the stress test is not expected to have a significant impact on the mortgage market. However, the ongoing cost of living crisis and rising interest rates would have meant the affordability checks would have played a more prominent role in assessing applicants’ eligibility for mortgages. Therefore, the removal of the stress test could help maintain transaction activity over the short-medium term that would otherwise have fallen foul at these affordability checks.

*calculations based off a 75% Loan-to-Value mortgage on a £300,000 home.

 

Author - Michael McGill

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