What new UK mortgage affordability test rules could mean for you

By Henry Sandercock
Tuesday, 21st June 2022, 1:48 pm
Borrowers will not be as heavily scrutinised by mortgage lenders under new Bank of England rules (image: Getty Images)
Borrowers will not be as heavily scrutinised by mortgage lenders under new Bank of England rules (image: Getty Images)

The Bank of England has changed mortgage affordability test rules in a bid to simplify the mortgage application process.

The move has raised eyebrows as it comes at a time of rising interest rates and a major cost of living crisis.

House prices are also continuing to outpace inflation and wage growth, with the average property now over £55,000 more expensive than it was before the Covid pandemic.

So what exactly does the Bank of England’s announcement mean - and how could it affect you?

Here’s everything you need to know.

Lenders currently have to perform two types of affordability check before offering out a mortgage (image: AFP/Getty Images)

What is a mortgage affordability test?

When you apply for a mortgage, lenders have to check that your finances are able to take the strain of repaying the loan.

This process was bolstered in the wake of the 2007-2008 global financial crisis, as the crash was partly caused by US banks making risky loans to people who struggled to pay them back.

According to the Bank of England, high levels of indebtedness can “amplify” a recession because households struggling to repay debt tend to sharply cut back on their spending in economic downturns.

In 2014, the UK introduced two mortgage mechanisms to reduce the risk of this kind of eventuality.

These were:

  • A stress interest rate for lenders when assessing prospective borrowers’ ability to repay a mortgage (i.e. a check to see whether they could cope with higher interest rates)

  • A loan-to-income (LTI) limit, which caps the number of mortgages that can be given to borrowers at LTI ratios at or greater than 4.5

The global financial crisis was partly caused by banks lending money to people who couldn’t pay it back (image: AFP/Getty Images)

What has changed with mortgage affordability tests?

The Bank of England has announced that the ‘stress test’ mechanism will be scrapped, leaving only the LTI limit as a way to ensure lenders can repay what they owe.

The change is set to come into effect from 1 August 2022.

Explaining its decision, the independent public body explained that ditching the test would retain an “appropriate level of resilience to the UK financial system” while also making mortgage rules “simpler, more predictable and more proportionate”.

The Bank’s Financial Policy Committee (FPC) has judged that the LTI limit is likely to have a larger role than the stress test in preventing a rise in overall household indebtedness and the number of highly indebted households in a scenario of rapidly rising house prices.

Mortgage affordability checks are intended to stop a repeat of the 2007-2008 global financial crisis (image: PA)

It also believes the LTI limit will be enough alongside the wider assessment of affordability required by the Financial Conduct Authority (FCA)’s responsible lending rules.

A consultation looking at the impact the change could have on mortgage lending was launched by the Bank of England in February, with the organisation reporting the majority of responses were supportive of the change.

What do mortgage affordability rule changes mean for you?

It is unlikely that you will notice an immediate change when the stress test is scrapped.

The Bank of England has said lenders will not need to make changes, as their existing checks should already comply with the FCA’s responsible lending rules.

The Bank of England said the stress test was not as integral to mortgage affordability checks as the LTI (Photo: Getty Images)

According to Gemma Harle, MD at Quilter Financial Planning, the change could have the effect of making it harder for first time buyers to get on the property ladder.

“One of the main drivers behind ‘generation rent’ is the fact that house prices have massively outstripped wage growth. Due to high house prices, first-time buyers also need very sizable deposits,” she said.

“In the current fiscal environment saving this type of money will be very difficult due to increasing rents and the cost of living. On top of this, inflation will be eating away at any other savings they have sitting in cash.

“House prices have become further and further out of reach for prospective buyers and this change in the affordability rules could perpetuate unsustainable further growth as it steps up demand in a market already suffering with limited stock.”

Data from Rightmove released on Monday (20 June), showed the average asking price across Britain stands at £368,614.

The June data marked the fifth month in a row that prices hit a record high.

However, HMRC figures suggest the housing market may be cooling, with transactions 5% lower in May 2022 than in May 2021.

Property purchases remained above 2019 levels, according to the data.