The Bank of England would expect to loosen its mortgage affordability rules if the UK experienced strong house price growth, it has said.
In a working paper titled Modelling the Distribution of Mortgage Debt, out this week (July 3), the central bank tested the regulation of affordability in two different scenarios — a ‘business as usual’ one and one it named the ‘upside scenario’.
Currently, the BoE restricts mortgage lending in two ways: lenders must ‘stress test’ any mortgage offered as if the base rate rose 3 per cent in the first five years of the mortgage, and mortgages with a loan-to-income ratio at or above 4.5 may not exceed 15 per cent of the lender’s new lending.
Such rules were introduced by the Financial Policy Committee 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.
This week’s paper looked at whether these requirements were applicable if the state of the housing market was to shift and examined whether LTI and loan-to-value norms would need adapting.
Using the levels of mortgage lending in 2016 as a basis, the paper considered how the distribution of debt could have evolved up to 2023.
In the first scenario — where house price growth is close to 5 per cent for a few quarters (slightly weaker than in 2016) before stabilising at just below 4 per cent annually and household income growth is about 3 per cent (similar to 2016) — the aggregate house price to income ratio rises only slightly.
The bank concluded that under this scenario, there would only be small changes in the stock of UK mortgage debt and it would be unlikely to change LTI and LTV rules.
However, the bank predicted that in the ‘upside scenario’, banks would be able to loosen their underwriting standards and relax LTI and LTV rules.
In such a scenario, conditions in the housing market change significantly.
House prices pick up pace — growing by about 7 per cent annually — but income growth remains the same, so the average house price to income ratio is driven upward.
In this scenario, the bank assumes the base rate is steady and mortgage approvals — consumers being approved to take out a mortgage loan — increase.
The bank stated that in such a scenario it would expect and accept a "substantial increase in the number of high LTI loans", consistent with a "pattern seen during previous UK housing cycles".
It added: "We also assume that banks would loosen their underwriting standards, permitting an increase in mortgages with LTI ratios up to 6, and performing affordability tests using a stressed rate of 5.5 per cent instead of the 6.75 per cent (prevalent in 2016)."
According to the bank, this relaxation of policies would be consistent with a broader scenario in which rising house prices, and the resulting stretch to borrower affordability, could reasonably be expected to cause some banks to adjust their affordability criteria in order to avoid a reduction in mortgage approvals or a loss of market share.
The bank’s ‘upside scenario’ is at odds with today’s reality, however, as just this week Nationwide’s house price index showed UK annual house price growth remained below 1 per cent for the seventh consecutive month.
But some industry experts have commented that the BoE’s stress testing criteria is too stringent, even in the current climate.
Last month, broker firm John Charcol urged the bank to rethink the "anachronistic" way mortgage applications are stress tested to allow more consumers to access the market.
Its argument was founded on the fact the base rate had remained below 1 per cent for more than 10 years and that a 3 per cent stress test was "more in line with the base rate pre-crash".
imogen.tew@ft.com
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