Most lenders should have had similar affordability criteria in place before the rules actually came into force, so there should not be too much difference to the position before MMR day. What is different though is the number of questions asked of borrowers in order to verify affordability.
Lenders will now require more evidence on borrowers’ expenditure in order to assess whether a loan would be affordable given current expenditure on essentials. While the assessment of affordability in itself is not controversial, the degree to which certain expenditures are considered essential is somewhat subjective, as is the capacity for prospective borrowers to cut back on it.
Rumoured interrogations about the required frequency of hairdressing appointments clearly fall short of the reasonableness test, but there is still the possibility to cut back on other types of spending considered essential – such as meals out or, should the need arise, reducing energy consumption in the home. Indeed the FCA acknowledges that there is wriggle room in reality by making provision for transitional arrangements to allow lenders to waive some of the affordability requirements for existing borrowers.
It is worth revisiting exactly what the rules say and then examining what this might mean in terms of affordability for a family on average earnings in the UK. Taking into account the effect on available income after tax and national insurance and essential spending, shows what is left for lenders to consider in their calculations.
Using government data on average earnings and expenditures – adjusting for tax and national insurance, current house prices and interest rates – we can assess how affordable a loan might be now and how that changes according to interest rate and mortgage-term assumptions. For a family with one child under two at nursery and both parents working full time, the mean gross average household income is about £64,500. After tax and national insurance, it falls to about £50,000 and after spending on council tax, food, transport and utilities it falls to about £35,000.
Under different interest rate and mortgage-term assumptions, the percentage of income remaining varies significantly, from 68 per cent to 46 per cent, even without varying the LTV. So it is clear quite how much of a difference the rate assumptions make, even when looking at just the basic essential expenditure.
The Financial Policy Committee has now adopted the power to be able to stipulate the interest rate lenders use in their affordability stress test. Even though it has not exercised the power, the message is clear: it has this in mind as a way to regulate the availability of credit, should it become more concerned about the pace of growth in the housing market and the threat it might pose to both consumers and the stability of the financial system.
The FCA rules do not limit salary multiples, loan-to-value ratios or the length of mortgage terms, but there is always the potential that they may consider these in future, especially as there are international precedents for these. Indeed, governor Mark Carney oversaw the implementation of several measures aimed at cooling Canada’s housing market during his term as governor of the Bank of Canada between 2008 and 2013.
| 2008 | 2010 | 2011 | 2012 | |
| Announcement date | 9 July | 16 February | 17 January | 21 June |
| Implementation date | 15 October | 19 April | 18 March | 9 July |
| Maximum amortization period | From: 40 to 35 years | From: 35 to 30 years | From: 30 to 25 years | |
| Loan-to-value (LTV) limit for new mortgages | From: 100% to 95% | |||
| LTV limit for mortgage refinancing | From: 95% to 90% | From 90% to 85% | From: 85% to 80% | |
| LTV limit for investment properties | From 95% to 80% | |||
| Debt-service criteria | Total-debt-service (TDS) ratio capped at 45% | Required that all borrowers qualify for their mortgage amount using the greater of the contract rate or the interest rate for a 5-year fixed-rate mortgage in the case of variable-rate mortgages or mortgages with terms less than 5 years | Gross-debt-service (GDS) ratio capped at 39% and TDS ratio at 44% | |
| Other selected changes | (i) Established a requirement for a consistent minimum credit score, with limited exceptions (ii) Strengthened loan documentation standards to ensure reasonableness of property value and of the borrower’s sources and level of income | As at 18 April 2011, mortgage insurance is no longer available for non-amortizing home-equity lines of credit | Mortgage insurance limited to homes with a purchase price less than $1m | |
Source: Bank of Canada Financial System Review, December 2012, CML |
All of these measures have helped to slow household credit growth in Canada, with the restrictions introduced in mid-2012 appearing to have the most pronounced impact. The Canadian authorities estimated that one in six higher LTV loans that took place in 2010 would not be feasible under the revised criteria. The critical driver appears to be shortening the maximum repayment period from 30 to 25 years (that is, back to its pre-2006 position).
So, overall the new affordability rules are unlikely to make a huge change to existing underwriting criteria, but the message from the regulator is clear. The housing market is the focus of beady eyes at the FPC, FCA and PRA, anxious to prevent any threat to the stability of the financial system. The chancellor will also be keen to avoid any nasty surprises coming from the sector in the run-up to the next general election.
Fionnuala Earley is residential research director of Hamptons International
Key points
■ The introduction of MMR rules means lenders will need more evidence on borrowers’ expenditure.
■ We can assess how affordable a loan might be now and how that changes according to interest rate and mortgage-term assumptions.
■ The Financial Policy Committee has now adopted the power to be able to stipulate the interest rate lenders use in their affordability stress test.
