The Bank of England has announced that it is scrapping the mortgage affordability test as of 1 August 2022.
After its review of the mortgage market, the Financial Policy Committee has stated that it will remove its recommendation for the test. The news comes despite the Bank of England’s decision to increase interest rates to 1.25%.
This is the fifth increase in a row, in a bid to combat the rising inflation rate, which is nearing 11%.
The affordability test has been in place since 2014, having been introduced to avoid a similar credit crunch to the one that occurred in 2007. However, the Bank of England has reviewed alternative systems and believes that the mortgage affordability test is no longer a viable Recommendation.
What is the mortgage affordability test?
The mortgage affordability test is a Recommendation by the Bank of England that has the aim of assessing prospective borrowers’ ability to see if they can afford the repayments each month. The test looks for evidence that borrowers are in a position to cover the mortgage repayments in addition to their standard monthly spending, such as bills, debt repayments and household expenses.
Individuals have to collate evidence to demonstrate their personal finances. This includes proof of their income (such as payslips), bills (such as electricity, gas and mobile phone) and credit card statements.
The affordability test also acts as a ‘stress test’ to analyse borrowers’ personal finances to see how they would cope with drastic circumstances. This could include a family member falling seriously ill, borrowers losing their jobs or interest rates rising.
The affordability test forms part of the property buyers’ mortgage application. It shows their likelihood of meeting actual mortgage payments. However, the test is only a suggestion of much someone is able to borrow – it doesn’t give a detailed overview of their personal finances.
The test can take around an hour and is conducted in-person, over the phone or via a video call with the prospective lender. Individuals with healthier finances are at a higher chance of passing the test and receiving a formal mortgage offer.
What happened to borrowers who failed an affordability check?
There are some situations where individuals may fail their mortgage affordability test. This could be for reasons such as too much debt, or too much expenditure each month. In these scenarios, individuals can take the time to sort out their personal finances to boost their credit score.
Alternatively, the lender may offer a smaller mortgage, which will mean that borrowers will have to buy a house on a lower budget.
It’s advisable that hopeful borrowers leave time between each mortgage application. The chances are that the next bank or building society would also reject the application based on the same reasons and it could further damage the individual’s credit score.
Why was the mortgage market affordability test scrapped?
The Bank of England has decided to cancel the affordability test as it has determined that other rules, such as the cap that is given to mortgages based on the borrower’s income, are more likely to play a “stronger role” in reducing the risk of increasing household debt following significant price growth in the housing market.
Lenders do not have to make any changes as the loan to income (LTI) ‘flow limit’ system will remain in place. The other affordability requirements they already use are also compliant with the Financial Policy Committee’s mortgage market framework.
What does the scrapping of the mortgage affordability test mean for borrowers?
The move has been met with some controversy as it could mean that homeowners may face higher repayments on their mortgages. Borrowers won’t have to pass the affordability test to prove that they can make the repayments. Instead, the mortgage cap will calculate how much they can borrow based on their income.
Lenders will set their own tests to calculate how much they want to loan borrowers, based on the risk requirements individually set out by the banks and building societies. This could mean that lenders are more flexible with their loans, which would prove a welcome relief to many borrowers.
Mortgage lenders will use stress interest rate tests as a reflection of where they suspect rising interest rates will be in the five years following the
The new system could benefit some borrowers who have previously been disadvantaged. They may stand a better chance of a loan that is calculated based on their income, rather than their day-to-day spending and other measures. Many first-time buyers have previously failed affordability assessments, even though they have been regularly paying rent each month that far exceeds mortgage repayments.
How much can mortgage lenders give to borrowers?
Using the affordability test, the amount that buyers can borrow is influenced by their salary and month-to-month expenditure. Most banks and building societies will give borrowers around four and a half times their annual income, which is the maximum that they can lend. The cap is another previous Recommendation by the Bank of England, but it hasn’t been withdrawn as the affordability test has. However, some critics do want it to be raised to 20%.
Borrowers can be lent more if they are in a certain profession, have a larger deposit or have high earnings. For example, a ‘professional mortgage’ can give borrowers in roles such as doctors and dentists a higher loan. This is because lenders think that these types of careers offer increased wage growth.
Some lenders may offer a higher multiple if borrowers are putting down a deposit of over 25%. The borrowers may also be offered a higher multiple if they have a high income. Most lenders require borrowers to earn over £100,000 to qualify for this.
Borrowers who don’t meet the above criteria can expect to receive four and a half times their income as the maximum loan. However, all lenders must meet the strict guidelines that have been implemented by the Bank of England. To help lenders calculate how much they should give borrowers, they would ask borrowers to complete the affordability test, but this is no longer the case.
Summary
The Bank of England has announced that they are withdrawing their Recommendation for the mortgage affordability test from 1 August 2022. This means that lenders will no longer have their personal finances analysed before they are offered a mortgage. Instead, banks and building societies will base their mortgage loans on the income of borrowers. This will give more flexibility to lenders and could potentially enable more property buyers to get accepted for a mortgage on their first application.
The decision has been based on an attempt to help lenders and borrowers in a market of rapidly rising house prices and inflation in the UK financial system. Currently, the Bank of England’s previous Recommendation of a loan to income (LTI) ‘flow limit’ system will stay in place.
