Bank of England overhauls mortgage affordability rules

Bank of England overhauls mortgage affordability rules

Mortgage lenders have been told to test affordability in a new way which could see huge swathes of people priced even further out of homeownership.

The Bank of England has told lenders to test affordability by using a 3 percentage point increase in their current reversion rate – usually the standard variable rate – rather than its previous rule introduced in 2014 which said they should consider a 3 percentage point increase in the Bank Rate.

The Bank base rate is at a record low of 0.25 per cent. Once lenders include their margins, stress rates typically hit 5 per cent and above. 

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But in March this year Which? found that the average SVR was 4.56 per cent, meaning borrowers will have their affordability tested on a rate of 7.56 per cent.

The Bank of England’s research found that in the last quarter of 2016 the average stressed rate was around 6.8 per cent with the new rules pushing this closer to 8 per cent.

In its Financial Stability Report, published today, the Bank of England has said its previous rule was too open to interpretation by lenders.

For example, it said lenders could make different assumptions about whether the appropriate rate to use was the one at origination or the reversion rate.

In its report the Bank of England said: “Lending conditions in the mortgage market are becoming easier and competitive pressures in the market remain.

“So there is a risk that lenders loosen the standard at which they test affordability, especially if there is significant scope for interpretation of the policy.

“The new recommendation promotes consistency of implementation across lenders and insures against the risk of loosening underwriting standards.

“It also ensures that borrower affordability is tested in the event that the borrower is unable to refinance their mortgage at the end of the fixed-rate period, which is appropriate given that — in times of stress — some borrowers may be unable to do.”

The Bank of England found that there was “significant variation” across lenders on the stressed mortgage rate used to assess affordability compared to their current SVRs.

Around half of the mortgages extended in 2016 Q4 were tested using a stressed interest rate of SVR plus 2.75–3.25 percentage points.

About 30 per cent of mortgages were tested at a lower rate, and about 20 per cent at a higher rate.

The Bank’s estimate is that, had the new recommendation been in place in 2016, it would have reduced mortgage approvals by less than 0.5 per cent relative to the previous recommendation, with a slightly larger impact on smaller lenders than on the major lenders.

Speaking to FTAdviser's sister title the FT earlier this year, Peter Hill, chairman of the Council of Mortgage Lenders (CML) and chief executive of Leeds Building Society, said the current rules were already too onerous, and were "locking people out of the market”.

He said he was not speaking on behalf of the CML but in a personal capacity.