Mortgage affordability test scrapped as house prices cool

In a slightly bizarre twist, as the Bank of England was announcing its recent interest rate increase of half-of-one-percent, it was also scrapping a key affordability test that lenders had to conduct to ensure borrowers could afford… an interest rate increase!

No return to the wild west of lending

Despite scrapping the affordability test, which was designed to assess whether borrowers could continue to afford their mortgage repayments in the event of a 3% increase in interest rates, the Bank made clear that other rules remain that will avoid a return to the ‘Wild West’ of mortgage lending that led to the 2008 financial crisis.

It is hoped that removal of the stress test will enable more would-be homeowners to get on the property ladder. Rather than purely looking at affordability at the point of mortgage application, the test considered the impact of gradual but cumulative increases in the underlying rate. Whilst some may have the protection of a fixed rate period, as those fixed rate periods or discounted deals end, there will be a stepping off point, and it is this that can be the undoing of many borrowers.

Following more than a decade of rate reductions or static rates, it may seem odd to make this move as we are clearly entering a phase of rate rises over the coming years. But the Bank of England believe other rules, lending criteria and the general cost of living crisis will continue to temper and control borrowing. 

Lenders own appetite for risk

Removal of the affordability test puts more focus onto individual lenders and their own appetite for risk. Since 2008, most lenders have tightened their own rules on borrowing ratios and macro regulation around liquidity and internal stress testing will mean few are rushing to start offering unaffordable loans to homeowners.

The Bank of England pointed out that lenders maintain loan-to-value and loan-to-income ratios that will provide a natural cap to over borrowing and reduce the chances of buyers finding themselves with the level of negative equity that the subprime market created around the turn of the century.

Housing marketing ‘cooling’

Whilst house prices continued to climb, hitting a record in July 2022 and adding more pressure to the cost of living; stats from The Halifax suggest a ‘cooling’ through July and into August, with the number of mortgage applications slowing.

Almost continuous increases in the average house price, demand outstripping supply and historically low interest rates have created a monster of late, fuelling the wider inflationary pressures. But with multiple interest rate rises this year, other household costs rising and a stark warning from the Bank of England about a recession, this record breaking period may be ending.

So it may be that the timing of the move by the Bank of England, to scrap the affordability test, comes at a point whereby the market can and will exercise a little of its own self-control.