Can you afford to repay a mortgage? It’s the biggest question lenders want an answer to. In the wake of the 2008 financial crash, the Bank of England decided to impose rules and put in place a mortgage affordability test.
Since then it has become normal practice for lenders to run a mortgage affordability test on potential borrowers, looking for evidence they’d be able to cover their monthly mortgage as part of everyday spending.
On the 20th June 2022, the Bank of England announced that they are withdrawing their mortgage market affordability stress test recommendations, which will likely come as a relief for some potential homeowners.
What were the Bank of England recommendations on affordability tests?
Recommendations for lenders to assess individual mortgage viability were:
- A stress interest rate for lenders is imposed when assessing prospective borrowers’ ability to repay a mortgage. Specifically, that meant testing whether you could still afford your repayments with a 3% mortgage rate increase above your lender’s standard variable rate.
- The loan to income (LTI) ‘flow limit’ limits the number of mortgages that can be extended to borrowers at LTI ratios at or greater than 4.5.
The Bank of England is specifically removing the requirements for a stress test but keeping the recommendations for LTI caps to remain.
Why were affordability tests introduced?
The primary reason for the Bank of England to take these measures was that there were no loosening standards from lenders, which could possibly lead to an economic downturn.
It also made these recommendations to ensure households didn’t put themselves under any undue financial pressure and put their financial stability at risk.
When will the mortgage affordability test be dropped?
According to their news release, their recommendations will be dropped from the 1st August 2022.
Why are mortgage affordability tests being withdrawn?
The Bank of England regularly reviews its recommendations. It was agreed, following a financial stability report, that loan to income limits would play a stronger role than the affordability test in guarding against an increase in household debt.
What does this mean for lenders and those applying for a mortgage?
Lenders will no longer have to check whether potential homeowners could afford mortgage payments at higher interest rates.
However, just because the recommendations change it doesn’t mean that banks will automatically change the way they review things. Lenders still need to lend responsibly.
What it does mean is potential additional discretions or innovations from lenders. An example of that could be lower stress rates for those with low income but with perfect credit and years of experience paying their rent. Opening up possibilities for those that previously fell short on an affordability test before.
The average standard variable rate has reached a 13-year high of 4.91%, according to Moneyfacts, a rise of 0.51%since December 2021.
Based on that average, the removal of the affordability stress test means that a typical borrower will no longer be assessed on whether they could hypothetically afford an interest rate of 3% above 4.91%.
In reality, due to the rising cost of living and rising interest rates, lenders have already been altering their affordability calculations.
For example, Santander has factored increased national insurance, household expenditure and dividend income tax rates into its current affordability calculations.
However, the Bank of England has said that no action is required from lenders as a result of the announcement as current affordability assessments should already be compliant with the FCA’s (Financial Conduct Authority) Mortgage Conduct of Business framework.
Whilst some may see this as a reckless move by the Bank of England, in fact, they have only removed the stress test recommendations.
The fact remains that the loan to income ratio recommendations remain in place and provide a robust safeguard against irresponsible lending, as the Bank of England suggests.
Furthermore, affordability checks have been blamed for stopping some first-time buyers from taking out mortgages that would be cheaper than their rent. It should therefore have a positive impact on certain borrowers who have been disadvantaged when it comes to getting on the property ladder.
The withdrawal should further mitigate some of the impacts of higher interest rates that have made mortgages less affordable in recent months.
Much will depend on how lenders will apply the recommendations, which should become clear over the next few weeks.
In reality, you will still need to prepare for some sort of affordability test. What that will look like will depend on the individual lender. You will need to be able to prove your income, that the property you’re looking to make an offer on is within your means and that what you are asking for in terms of a mortgage loan does not exceed 4.5 times your income.
If you’re unsure about this, run it through our online mortgage calculator.
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