In a move planned last year, the Bank of England has this week removed what many saw as a safety net for the UK mortgage market. Introduced in 2014, the mortgage affordability test forced the borrowers to show they could cope with a three percentage point increase in interest rates. Seen as a means of avoiding a repeat of the 2008 financial crisis, brought about by a collapse in the US sub-prime mortgage market, the Bank of England removed this condition on 1st August.
While mortgage applicants must still stay within 4.5 times earnings when applying for a loan, many observers are puzzled as to why an element of the mortgage affordability test has been removed in the current environment.
Bank of England insists no relaxation of lending standards
Andrew Bailey, governor of the Bank of England, has been forced to defend this move amid concerns there could be a move back to high-risk lending. He has highlighted the overall framework, which still includes an array of checks such as the maximum 4.5 times earnings. However, Bailey also believes lenders are now “more efficient” and unwilling to sacrifice safety for new business.
Is there more to this than meets the eye?
There are several factors to consider, aside from suggesting that mortgage lenders will be “more efficient” in the future. Firstly, UK interest rates could move as high as 1.75% on Thursday if the rumoured 0.5% increase in base rates is confirmed. Using the former three percentage point test with base rates at 1.75% is very different to when base rates were 0.1%. While not the consensus, some economists believe that UK interest rates could peak at around 3% in early 2023, making the three percentage point test even more challenging.
Housing market
Recent data also shows that monthly mortgage transactions have fallen by around 50% compared to spring 2021. Even though the housing market is still reporting record price growth – the latest Nationwide figures suggest a 12% year-on-year increase – there are signs of a slowdown. Recent data from Zoopla indicates that house price growth has fallen to 8.3% and could be as low as 5% by the year-end. While still in positive territory, in relative terms, this is a fall compared to inflation.
Mortgage lenders keen to widen their net
It is obvious the Bank of England has come under significant pressure from mortgage lenders, keen to widen their net to those who may have fallen foul of the three percentage point test. However, while many see similarities to the 1990s and a move to “light touch regulation”, are we comparing apples and pears? Evidence suggests that loosening regulations in the 1990s may have contributed to the 2008 mortgage crisis. However, overall, regulations are now much tighter today.
In the background, there’s also the fact that the price of property is central to the wealth of many UK households. We have repeatedly seen governments and regulators bailing out the industry with what many see as artificial support. While this week’s move is unlikely to prompt a raft of casino-style lending in the mortgage market, it does highlight the importance of supporting the property market and the mortgage industry.
Interest rates and the affordability test
As interest rates continue to rise, the three percentage point test was always going to become problematic at some point. While central to the mortgage affordability test since 2014, other restrictions are still in place to ensure responsible lending. Whether or not this is a means of supporting the property market and the mortgage industry through expected economic headwinds is debatable.
As the UK faces a potential recession, with wages under pressure and household budgets stretched to the limit, this may give homeowners and mortgage lenders a little breathing space.