Bank of England considers withdrawing affordability test for mortgage lending

The Bank of England is considering ditching an affordability rule for mortgage lending and wants to know what impact this could have on the market.

Two recommendations were introduced in 2014 to help guard against a material increase in household indebtedness that could potentially make an economic downturn worse.

These were a loan-to-income limit and the affordability test, which specifies a “stress interest rate” for lenders to consider when assessing a potential borrower’s ability to repay a mortgage over time.

The loan-to-income limit is likely to play a stronger role than the affordability test in guarding against the number of highly indebted households, analysis previously found. It limits the number of mortgages that can be extended at loan-to-income ratios at or above 4.5 to 15% of a lender’s new mortgage lending.

The Bank is seeking views on the proposal to withdraw the affordability test, in a consultation which asks how lenders and the mortgage market would respond if the recommendation were withdrawn.

Sarah Coles, senior personal finance analyst at Hargreaves Lansdown, said the affordability tests have “seemed increasingly draconian over time, because they refer to reversion rates – the mortgage rate you’re moved to at the end of your deal – and insist you should still be able to afford your mortgage if your rate rose to three percentage points above your reversion rate”.

“Despite mortgage rates dropping dramatically in recent years, reversion rates have remained remarkably sticky, so in order to qualify for a cheap mortgage, buyers need to prove they can afford a really expensive one.”

The Bank wants to know what effect withdrawing the measure may have on the housing market as a whole and on particular segments.

The consultation will close on May 6, after which the responses will be considered by the Bank’s Financial Policy Committee.

On current evidence, the loan-to-income limit – without the affordability test, but alongside the wider assessment of affordability required by Financial Conduct Authority (FCA) rules – should deliver an appropriate level of resilience, but in a simpler, more predictable and more proportionate way, the consultation paper said.

The FCA’s rules set out standards that mortgage lenders must meet when assessing affordability. They cover the assessment of income, spending and, in relevant cases, the effect of future interest rate rises.

It added that analysis suggests the affordability test could have caused around 6% of borrowers (roughly 30,000 per year) to take out smaller mortgages than they would have been able to in its absence.

House prices have jumped to a string of record highs during the coronavirus pandemic.

Ms Coles continued: “The worry is that this could mean more people able to borrow more money, which could make them vulnerable to over-stretching themselves to afford sky-high prices.

“Any weakness in the property market in the coming months could add the risk of negative equity for those who have borrowed much more. However, the Bank calculates that a combination of the FCA’s affordability rules and its own rule that limits the number of mortgages with a high loan-to-income will offer enough protection.”

Myron Jobson, senior personal finance analyst at interactive investor, said the risk of “people biting off more than they chew financially to purchase a property” could be a particular issue among first-time buyers.

He added: “So any changes should be approached with a significant degree of caution.”