Why are mortgage affordability checks being axed and what's changing?

In 2014, the Bank of England introduced mortgage affordability checks, to ensure that property buyers did not take on levels of debt that they couldn’t pay back — especially if interest rates increased.

On 20 June 2022, following a review of the current mortgage market, they announced the rule’s withdrawal as of 1 August.  

So what has prompted this move, and what impact will it have? 

What were mortgage affordability checks all about? 

The checks were first introduced after the global financial crisis in 2008, essentially to prevent borrowers from taking on more than they could manage, protect the central banks from increased levels of debt, and tighten up mortgage underwriting standards. 

Borrowers had to prove that they could still afford to make their mortgage repayments, even if their mortgage rate increased above their lender’s standard average rate of 3 per cent.

The check was designed to avoid financial instability in the event of interest rates suddenly rising. 

Another element of the test, the loan to income (LTI) flow limit will not be withdrawn in August.

This recommendation was designed to limit the number of mortgages that can be extended to borrowers at LTI ratios of 4.5 or more.  

The Bank of England’s Financial Policy Committee believes that the LTI flow limit is more effective in guarding against rising household debt than the mortgage affordability check.

Particularly when working in tandem with the wider assessment of affordability demanded by the Financial Conduct Authority’s (FCA) Mortgage Conduct of Business responsible lending rules. 

Why is the mortgage affordability check being withdrawn? 

When the check was initially launched in 2014, interest rates were projected to rise to just over two per cent over the ensuing five years, but in hindsight, it seemed very unlikely that this level would be reached within the timeframe.

The Bank of England then decided that the mortgage affordability check was no longer needed. 

What are the benefits? 

The change is designed to maintain the resilience and stability of the UK’s financial systems but in a simpler and more predictable way.

This is the wider story, but how will it benefit individual borrowers? 

This is essentially positive news for legitimate borrowers, who may have found their plans thwarted by the affordability tests.

Banks will still be looking closely at your financial status and ability to meet repayments, and they still have a duty of care to their customers and internal risk committees.

The difference is that there could now be greater flexibility and a more innovative approach by lenders.

Lower stress rates could mean that potential borrowers with a low income, a sound credit history and years of experience meeting their rent payments will be able to get a mortgage, where before they would have been locked out of home ownership. 

In some cases, you might be able to borrow significantly more to buy a property, but the removal of the check is not in any way designed to open the floodgates to unchecked lending. Responsible lending is still very much the ethos. 

The changes will certainly be good news for first-time buyers, who tend to have smaller deposits and lower incomes.

The affordability rules have often been a frustration for these borrowers in the recent past, but securing a mortgage should now be less stressful. 

The key advantage to the removal of the mortgage affordability check is that lenders will no longer have to check whether you can afford mortgage payments at a higher interest rate.  

Will scrapping the checks affect the wider economy?

It’s unlikely that the removal of affordability checks will have a significant impact on the wider UK economy because as we’ve mentioned, there are still plenty of control measures in place.

Measures such as the LTI flow limit prevent people from borrowing more than they can afford and creating wider economic instability.

It’s possible that a larger number of first-time buyers will be able to get onto the property ladder without the restriction of the checks, which would have a positive impact on the property sector and the economy as a whole. 

Of much greater concern currently is the rise in inflation and the cost of living, which has been accompanied by a series of small but significant interest rate rises.

The UK economy shrank by 0.3 per cent in April according to the Office for National Statistics, and many economists are now predicting a recession within the next 12 months. 

Can we learn from recent lending history?

The financial crash of 2008 was largely triggered by reckless mortgage lending to high-risk borrowers — particularly the sub-prime mortgage boom in the USA.

In the aftermath of this global downturn, interest rates plummeted, but it was widely assumed that they would rise again relatively quickly.

This expectation led to the precautionary introduction of affordability safety margins such as the checks — put in place to protect borrowers from sudden rises in the interest rate. 

In reality, the Bank of England has only increased the interest rate slowly and in small increments, making the checks seem over-cautious - in fact stifling the market, especially for first-time buyers.   

Given that there are plenty of sensible measures in place to prevent a repeat of the 2008 collapse, the Bank has justifiably decided that the mortgage affordability check is a precaution that we no longer need. 

Whatever the criteria and checks being applied by your mortgage lender, the first calculation starts with you.

Be realistic about what you can comfortably afford, now and in the future. Look carefully at your income and outgoings.

Think about how your circumstances might change in the coming years, and build in a little flexibility to your plan because no one can really predict what will happen in the economy and the housing market with complete accuracy. 

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