Mortgage affordability tests: what do the new Bank of England proposals mean for house prices and first-time buyers?

Mortgage lending rules could be simplified under a Bank of England proposal to withdraw its affordability test.

The Bank has launched a consultation about whether its recommendations — introduced in the 2014 Mortgage Market Review to guard against an excessive build-up of household debt — are both still required to prevent a financial crisis similar to the 2008 crash.

At the moment no more than 15 per cent of mortgages lenders offer homebuyers can be for more than 4.5 per cent of their household income.

Mortgage lenders are also required to perform strict ‘stress tests’ on borrowers’ finances to see how easily a homebuyer could continue to repay their mortgage in the event of a three per cent rise in interest rates or after an income reduction.

The Bank’s Financial Policy Committee regularly reviews these recommendations. Its latest analysis confirmed there could be a massive impact on the country’s financial stability in the event of rapid house price growth, for example.

However, it also found that the loan to income limit is a better tool for preventing this than the current affordability stress test. Instead, the simpler assessment of affordability already required by the Financial Conduct Authority could be used alongside LTI ratio limits.

The Bank of England announced on February 28: “The Financial Policy Committee has [...] decided to maintain the LTI flow limit Recommendation, but has decided to consult on withdrawing its affordability test Recommendation.”

Nicholas Mendes, mortgage technical manager at mortgage broker John Charcol, said: “Lenders will still need to ensure that mortgages remain affordable, but the repayments would be based on market expected interest rates movement in the next five years or a per cent increase on today’s rate, whichever is higher.”

While this could mean, in the short term, homeowners are able to borrow more, added Mendes: “Lenders could also choose to not make any changes as predicting where rates could be in five years’ time seems almost impossible.”

What impact could changes have on house prices?

In the short term, buyers would be able to borrow more and have greater affordability when it comes to finding a home. In the long term, homeowners would all be in the same boat so broadly speaking no individual homeowner would be markedly better off.

“This allows people to bid , or increase their offers, and as a result risks competition against the same homeowners that would have been searching for the same properties before — but at higher values,” said Mendes.

What might this mean for London first-time buyers?

The committee judged that raising a deposit remains the biggest barrier to home ownership for first-time buyers.

The average price of a London Halifax.

UK-wide, the average first-time buyer paid £264,140 with an average deposit of £53,935.

The Bank’s report suggested that its affordability test may have caused some six per cent of borrowers, equating to around 30,000 a year, to take out smaller mortgages than they could have done in its absence.

But being able to secure larger mortgages doesn't necessarily mean buyers will necessarily get on the ladder faster, as greater spending power may lead to house hunters making higher offers and pushing prices up.

What does it mean if you bought using shared ownership?

An online calculator (ONS) shows you how much you would need to see your salary increase by to keep in line with inflation.

“Lenders are looking at implementing the ONS stats into affordability calculators more regularly, with lenders who have trialled it seeing the max borrowing reduce for homeowners,” said Mendes.

“This is a growing area of concern for those who are currently on shared ownership schemes, as based on potential future affordability modules owners who were able to buy [based on previous calculators] wouldn’t be able to afford the borrowing that they originally took out.”

Buyers who have already bought may find it difficult to increase their share of ownership, as lenders consider the increase in cost of living and higher monthly outgoings.

“The typical client that has bought through the shared ownership scheme hasn’t seen their income increase in line with inflation,” said Mendes.

For those looking to use the scheme, there are concerns that buyers would not be able to meet affordability critieria if it were to be revised in line with these ONS calculations.

What happens now?

The committee is seeking opinions as part of a consultation that will close on May 6. Key questions include the current impact of the affordability test on the mortgage market, the likely response by lenders and the mortgage market to its removal, and the possible effect on the housing market.

Should the FPC decide to withdraw the affordability test, it expects to remove it formally within 12 months of that decision being made.