As you will no doubt have read, in a week from now the Bank of England, in the guise of its Financial Policy Committee (FPC), will no longer require lenders to comply with the ‘affordability test’ it introduced back in 2014.
Designed to provide another layer of security and certainty around the ability of borrowers to be able to repay their mortgage should rates rise, it specified that lenders use a stress test interest rate. Effectively, could the prospective borrower still afford to pay their mortgage if rates were 3% above what they were applying for? If not, then they should be declined the loan.
Eight years is a long time in any market, and the Bank/FPC might well argue that this policy has served the market well, but it is no longer required. In fact, that’s exactly what it is saying.
From my understanding, it says that other measures will suffice – particularly the fact it is maintaining the loan-to-income (LTI) ‘flow limit’ requirement for lenders, which limits the number of mortgages that can be provided to borrowers at LTI ratios, at or greater, than 4.5. And the fact the FCA also insists lenders apply a stress test on borrowers, but this is a 1% rise.
However, as many have already pointed out, timing in this market is everything. And what has served the market well in relatively benign conditions, might arguably be adjudged to be worth holding onto during the current economic upheaval.
Dumping this measure – and I should caveat this by acknowledging that lenders might well continue to lend in the same way but are simply not required to anymore – at this time just looks and feels odd.
According to Bank of England figures, 6% of borrowers took out smaller mortgages each year than they would have been able to if the stress test were not in place. That is approximately 30,000 borrowers who in this new climate, could have secured a bigger loan that ‘technically’ they might not have been able to afford should their rates have gone up.
Doesn’t sound a particularly big borrower cohort, however, our market is full of examples where the relaxing of rules and regulations, eventually created a marketplace which was far looser and riskier for many more customers and lenders, than was originally envisaged.
Again, the pushback might be, that at those times, none of these ‘safeguards’ were in place, and therefore the whole system was open to significant abuse. Undoubtedly so, but there will be many who will be worried by even the slightest loosening of measures, especially for those who may be deemed most susceptible to increased rates, increased cost of living, increased everything.
The counter-argument of course is that this will allow people who have been unfairly ostracised from the mortgage market, due to these overly-strict measures, to actually secure a loan that can turn their house dreams into reality. Lenders too, might rightly argue, that they are not about to drive up the risk curve at breakneck speed, when they have spent the last eight years or so doing anything but.
For the vast majority, I tend to agree, but again it only needs a small number to think this is a major opportunity to do just that, and we find ourselves in an awkward and delicate situation where others might feel the need to follow.
From my perspective, it appears that the FPC may actually be ditching the wrong measure. Might it not have been better to review, or indeed abolish, the LTI flow limit instead?
The reason being that, the affordability measures can act as protection against the systematic risk of leverage by lenders. While the LTI limit which is being retained is actually a fairly blunt instrument, so in the type of low interest rate environment that we have had, it doesn’t protect against excessive leverage.
My view is that it would have been more appropriate therefore to change or ditch that LTI limit, which would allow lenders to meet the needs of a mortgage marketplace in which house prices have risen but wages have not at the same level. In other words, if they want to lend more of their funding to a borrower demographic at a higher LTI limit, they would have had the freedom to do so, managing their own risk, but with the over-riding protection of the affordability measure still in place.
That, clearly, is not the route that has been chosen, and we will all have to see just how this plays out in practice. As mentioned, even with this new-found ‘freedom’, lenders might feel they need the rigour the affordability stress test provided, even if they are not required to use it. Given the current economic headwinds we are facing, I tend to think it might be the best course of action, at least in the short to medium term.
Patrick Bamford is head of international business development at Qualis Credit Risk, part of AmTrust International