This August the Bank of England will relax its mortgage affordability tests, removing the stress testing introduced by the Financial Policy Committee (FPC) in 2014.
The withdrawal should mitigate some of the impact of higher interest rates that have made mortgages less affordable in recent months, and will come as welcome news to buyers who have struggled to keep up with significant house price growth over the past two years.
As such, it should provide more flexibility for lenders and borrowers, thereby opening up accessibility to mortgage debt and unlocking some more capacity for house price growth over the medium term.
But it’s unlikely to open the mortgage-credit floodgates, given both caps on the ability to lend at high loan to income ratios and a requirement for lenders to abide by less-stringent Responsible Lending and Financing rules.
What is the mortgage affordability stress test now?
Since 2014, mortgage lenders have had to test whether borrowers could afford their mortgage repayments if interest rates were to rise.
Borrowers who fixed for five years or more have essentially been able to sidestep these rules. Given that they have been able to do this without paying a substantial interest rate premium, we have seen a surge in this type of lending.
But those on shorter-term fixed rate or discounted variable rate mortgages have still accounted for roughly half of the mortgaged market. And these borrowers have had to show they could afford repayments at the much higher Standard Variable Rate (SVR) plus another three per cent.
(For context, the average five-year fixed rate mortgage with a 25 per cent deposit in May 2022 was 2.6 per cent. The average SVR at the start of June was almost double that, 4.9 per cent.)
How is the mortgage affordability stress test changing?
The Bank of England is now doing away with the affordability stress tests introduced eight years ago, instead relying on caps on high loan to income lending and other rules and guidance regarding Responsible Lending.
That means from August, lenders will instead have to test that individual borrowers can afford their contracted mortgage payments during the first five years of their mortgage, having regard to:
- where financial markets expect interest rates to move over that period; or
- rates one per cent higher than today (if higher).
In theory that opens up capacity for buyers to borrow more, though it isn’t yet clear to what extent.
Much depends on precisely how lenders apply the Responsible Lending Rules and, as importantly, the future relationship between their Standard Variable Rate and other interest rates available in the wider mortgage market. This is only likely to become clear over coming weeks and months.
What will relaxing stress tests do to the housing market?
And stress testing isn’t the only thing stopping banks from lending more money. As mentioned above, they also have caps on how much they can lend relative to borrowers’ incomes.
Specifically no more than 15 per cent of a bank and building society’s new mortgage lending can be at more than 4.5 times the borrower’s income. In addition many lenders have their own limits on loan to income ratios tailored to the borrower’s precise financial circumstances.
All this means relaxing mortgage stress tests is unlikely to open the mortgage-credit floodgates. It will let lenders be a bit more flexible and could provide some relief to first-time buyers struggling with affordability. But saving for a deposit is still likely to remain the most significant barrier to home ownership for many.
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