The BoE’s Financial Policy Committee currently requires mortgage applications to be stress tested at 3 per cent above the mortgage policy’s reversion rate — the rate the consumer will be 'reverted' to once any initial deal has finished.
This is typically a bank’s standard variable or follow on rate, which currently sits at an average of about 3.5 per cent or above, so most mortgage applicants will have to prove they can afford their mortgage policy at a minimum rate of 6.5 per cent for a five-year forecast.
The 3 per cent requirement was introduced by the FPC in its Financial Stability Report in June 2017. Before the change, lenders could use a range of approaches to stress the interest rate which caused inconsistency in the market.
According to Nick Morrey, product technical manager at John Charcol, the 3 per cent requirement is at odds with the BoE’s own expectations of how the base rate will behave in future years.
Notes from the latest Monetary Policy Committee meeting, part of the BoE, contained a forecast that any increase to the bank’s base rate in the next three years would be between 0.25 per cent and 1 per cent meaning a maximum expected base rate of 1.75 per cent.
The BoE’s base rate affects the rate at which lenders can borrow money from the money markets and in turn affects the consumer’s mortgage policy.
Mr Morrey said the idea of stress testing the mortgage policy at 3 per cent above the reversion rate was more in line with the base rate pre-crash, where the rate regularly sat at above 4 per cent.
By comparison, the base rate hasn’t been above 1 per cent for the past ten years.
Mr Morrey said: "Looking at the recent history of the base rate, isn’t the rate sat at below 2 per cent to be considered the ‘new norm’?
"The stress test should be rethought and rejigged. The test is currently anachronistic. Moreover, if whatever new system was regularly reviewed, tests could be adjusted if needed."
Mr Morrey stated that first-time buyers, some mortgage prisoners and ‘second steppers’ could all be helped if the stress test was reviewed and enabling such groups would help "get things moving in the market" without increasing the risks to unacceptable levels.
But the position of some banks is that stress tests are meant to protect the consumer against financial shocks, not just normal conditions, and ensure affordability if there is an unexpected fall in income or increase in interest rates.
Analysis from the BoE in its Financial Stability Report, published in June 2017, stated the margin of safety provided by the 3 per cent stress test was only equivalent to guarding against a 2-3 per cent rise in unemployment.
Some lenders said although the stress tests did mean some people were unable to take out a mortgage, it also meant people could be sure they could afford the policy in the long term which was important considering the number of policies now at 40-year terms.
They also rebutted the idea that stress tests would hold back first-time buyers and pointed out that first-time buyer numbers were on the up.
David Hollingworth, director at L&C Mortgages, agreed with Mr Morrey that the way mortgages are stress-tested could be reviewed.
He said: "We have had base rates nudge up a little bit, but it has been only nudges and from historic lows.
"To get rid of the stress test all together would be irresponsible but there’s a lot of logic to saying that it needs to be reviewed and the BoE itself is saying any rise in the base rate needs to be gradual.
"As time goes on, we do need to review how this rate affects different aspects, like the stress test."
Mr Hollingworth said one concern of reducing stress tests was that by increasing affordability in the housing market and allowing people to borrow more, the industry would see house prices rise.
He said: "The more people who can borrow and the more people who can borrow more money, we would probably see the average house price increase as demand goes up."
Ruth Whitehead, of Ruth Whitehead Associates, said the stress tests had been enforced to ensure the financial crash never happened again but said it "seemed they have shut the stable door after the horse has bolted".
She added: "Now, it seems like an overreaction which is not being reviewed in the light of today’s financial conditions.
"It’s all about balance. There should be stress testing for mortgages but in an appropriate way."
imogen.tew@ft.com
