MortgagesMar 25 2014

Stress tests

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As the mortgage industry gears up for the advent of the mortgage market review (MMR) rules, a survey suggests that many advisers and lenders are concerned about their possible impact. The research, conducted by the Intermediary Mortgage Lenders Association (Imla) shows that 64 per cent of lenders and 46 per cent of brokers are worried about the new rules.

More specifically, 50 per cent of brokers believe that more mortgage applications will be declined as a result of the new stress tests. Only 14 per cent of lenders believe that will be the case, while another 43 per cent believe that the stress tests may lead to more applications being refused (See Chart 1).

However, the figures show that the percentage of lenders concerned the stress tests will or may have a detrimental effect on applications has increased from 27 per cent in July 2013 to 57 per cent in January 2014. Back in July, 73 per cent believed it would have no significant effect. So why the rise in dread and uncertainty? Perhaps because the FCA has refused to be too prescriptive in setting out the rules on the use of stress tests?

Scope for variety

It specifies that lenders must “consider the likely future interest rates over a minimum period of five years from the expected start of the loan…” They must be able to justify the basis they use for determining likely future interest rates and they must assume that interest rates will rise by a minimum of 1 per cent over the period. The FCA does not specify how often lenders must review their stress rates or which rate the stress test should be applied to. Also, lenders do not need to make their interest rate assumptions public. Clearly there is plenty of scope for variation in the way that lenders apply the test.

The FCA suggests the forward sterling rate published by the Bank of England as an example of market expectations, but lenders are not bound to use it. In its feedback and final rules on the MMR (PS12/16) it also notes that most lenders currently take account of interest rate rises when assessing affordability, so the decision to compel them to apply a stress test “will not have a significant impact on current market practice”.

While intermediaries’ uncertainty about how adoption of the MMR rules will pan out for their clients is probably understandable, lenders’ uncertainty about their adoption and concern about the stress tests in particular is more worrying. It seems to suggest at the very least that they don’t know what to expect as they take specific approaches to the tests.

Some lenders are taking no chances. One unnamed lender is reported to have said that it will apply the forward sterling rate on the basis it is the only example given by the FCA. It believes that if other lenders rely on other bases it could have a major impact on the market.

So will the stress test have a significant effect or not? Gone are the days of simple income multiples and most lenders will have already built their affordability criteria into their mortgage calculators and are in the process of incorporating the stress tests if they have not already done so.

Peculiar

No wonder intermediaries are worried. The onus will be on them to continue to seek out the most suitable lenders for their clients, but the stress tests may throw up some peculiar results until the new regime is bedded in. “There could be some slightly unfamiliar results because of the MMR changes,” concedes David Hollingworth of London & Country Mortgages. “They may knock a few people out of the system who would have been accepted before. Hopefully, there will be relatively minor changes that may be unnoticed.”

So what effect will borrowers see? Mr Hollingworth says that they must expect to be asked for proof of lots of things and a greater breakdown of their monthly expenditure and the application process is already longer because of the need for greater detail. He also suggests that potentially things will slow even further as lenders adjust their systems and get them up and running.

Commenting on the research, Peter Williams, executive director of Imla, has a similar perspective, suggesting that the new regulations will have at least an initial dampening effect on the mortgage market and that the number of approvals is likely to fall in the short term “as new practices are set in stone and while any remaining gremlins in new IT systems and processes are ironed out”.

Meanwhile, lenders are beginning to put their cards on the table. Kensington caused controversy by publishing its household monthly living expenditure form, which some felt was too detailed. Nationwide revealed that it plans to be MMR-compliant by 14 April. As of that date, any unresolved decisions in principle will have to be reprocessed under the new regime.

Perhaps the drop in lender confidence about the stress tests on the threshold of the implementation of the MMR rules is just down to last minute nerves. We’ll know whether it was justified soon enough.