The Bank of England is considering ditching rules that limit how much people can financially stretch themselves when taking out a mortgage.
The central bank has launched a consultation in relation to changing the affordability tests that mortgage lenders currently adhere to – and doing so would allow more homeowners to borrow larger mortgages.
The consultation comes amid fears that this could push house price inflation even higher.
On the flipside onerous affordability checks that don’t reflect actual borrowing conditions have been blamed for stopping some first-time buyers taking out mortgages that would be cheaper than their rent.
The Bank of England is considering relaxing the affordability test, which specifies a stress interest rate for lenders when assessing prospective borrowers’ ability to repay a mortgage.
What are the mortgage rules that could be changed?
Two recommendations established by The Financial Policy Committee in 2014 to avoid household debt spiraling are under review.
These are a limit on the loan-to-income limit and an affordability test, which specifies a stress interest rate for lenders when assessing peoples’ ability to repay a mortgage.
The loan-to-income-ratio is the multiple at which banks will lend based on your annual salary.
Since 2014, banks have had a limit on the number of mortgages they can offer where someone is borrowing more than 4.5 times their salary.
There is also an additional affordability test, which means borrowers must prove they can still afford their mortgage repayments if these were to increase to 3 per cent above their lender’s standard variable rate.
SVRs are the default rate that people move to when fixed or other deals end and are far more expensive. Most borrowers switch to a new mortgage deal and don’t end up on a standard variable rate.
Despite concerns the rules are stopping people being able to buy, these affordability stress tests mean just 6 per cent of people had to take a smaller mortgage than they otherwise would have, according to the Bank of England. This equates to roughly 30,000 mortgages a year.
Although the loan-to-income rules will likely remain the same, the stress testing could be relaxed, meaning repayments could become based on the market’s expected interest rate changes over the next five years or a 1 per cent increase on today’s rate – whichever is higher.
Nicholas Mendes, mortgage technical manager at John Charcoal said: ‘The scrapping of current rules would be welcome by homeowners and brokers alike as this would be a boost for the market given the ever-increasing property prices.
‘This will give homeowners, at least in the short term, the ability to borrow more.’
Lender’s affordability calculators are in part defined by data from the ONS and this data reflects the rising costs of living.
Cost of living crisis could dent borrowers
Even were such changes to be made, there is a possibility that any impact will be nullified by lenders also having to factor in higher household bills into their affordability assessments.
‘We are expecting to see inflation continue to increase into 2023,’ says Mendes, ‘with multiple base rates rises, lenders could choose to not make any changes, because predicting where rates could be in 5 years’ time seems almost impossible.
‘As the costs continue to escalate, we could see lenders exercise caution and start to consider other factors to ensure the mortgage remains affordable.’
Are banks cutting back on loans as living costs rise?
Several lenders, including Barclays and TSB have already altered their affordability calculators due to rising rates and living costs, according to analysis by mortgage broker, Private Finance.
Santander became the latest lender to update its affordability calculator to reflect the current economic landscape and factor in rising inflation and interest rates.
Chris Sykes, mortgage consultant at Private Finance said: ‘We can expect more lenders to take these costs into consideration moving forward, especially after the removal of the energy price cap in April.
‘This means we can expect tighter affordability for some and lower loan amounts available than was previously the case.
‘This could reduce people’s maximum borrowing, which in turn could be a problem for those already in a tight situation.
‘We are already seeing the impact these changes are having with Barclays with a recent client able to borrow a very significant £100,000 less following the implementation of the changes to their affordability calculator.’
According to Sykes this could cause problems for homeowners as well as first time buyers.
For example, those needing to remortgage may find they can’t afford to refinance the mortgage amount and will therefore will be forced to remain with their current lender, which will likely mean paying more than if they had the ability to switch.
Furthermore, with house prices at record highs it will likely spell more bad news for first-time buyers.
Affordability may not be the only problem
Aside from lenders beginning to factor in the rising cost of living into their borrowing assessments, there are concerns that higher amounts of unsecured debts and serious adverse credit issues will be a common problem in 2022.
Cuts to government pandemic support measures has already caused borrowing on credit cards to jump to its highest level in more than a year, pushing all forms of household unsecured credit to £1.2 billion, according to the latest Bank of England data.
One third of people planning to buy this year could see their mortgage application rejected by mainstream banks and building societies, according to research by The Mortgage Lender.
It found that the pandemic has driven more people into building up unsecured debt, with concerns that the rising cost of living could exacerbate this trend in 2022.
Cuts to government pandemic support measures has already caused borrowing on credit cards to jump to its highest level in more than a year.
The study revealed that those hoping to buy a home this year have unsecured debts worth an average of £2,732, which is 34 per cent higher than the UK average of £2,035.
The Mortgage Lender’s research also found significant numbers of people were involved in serious ‘adverse credit’ events.
For example, 15 per cent of those planning to buy this year had previously received a default notice, whilst 8 per cent have previously applied for a Debt Relief Order or Individual Voluntary Agreement.
These situations could cause the majority, if not all, lenders to reject a mortgage application.
Peter Beaumont, chief executive at The Mortgage Lender said: ‘The past few years have been challenging for everyone and these findings illustrate just how many people planning to buy a home this year have also had to contend with credit issues.
‘The reality is a number of those who are expecting to buy a home this year are likely to see their mortgage rejected out of hand.
‘With more ‘buy now pay later’ products on the market and the rising costs of everyday items, there is a real risk that people will unknowingly walk into a bad credit score.
‘This is not only a concern for those first-time buyers trying to get onto the property ladder, but also for homeowners looking to remortgage in the next few years.
‘The risk for this group is that lenders no longer deem them a viable option, and they tick up onto the standard variable rate.
‘With the Bank of England expected to continue to raise the base rate over the next year, this could mean they end up paying substantially more in their repayments than expected.’
Best mortgage rates and how to find them
Finding a mortgage can seem confusing due to the huge range of deals on offer.
This is Money has partnered with independent fee-free mortgage broker L&C, to help you find the right home loan.
Our mortgage calculator can let you filter deals to see which ones suit your home’s value and level of deposit.
You can also compare different mortgage fixed rate lengths, from two-year fixes, to five-year fixes and even ten-year fixes, with monthly and total costs shown.
Use the tool at the link below to compare the best deals, factoring in both fees and rates.
Credit report that reveal the borrower hasn’t adequately managed debt in the past will put many lenders off.
What does too much debt mean for a mortgage?
Typically, the more unsecured debt you have the lower the maximum borrowing amount you can achieve.
Unsecured debt includes personal loans, buy now, pay later, credit cards and car finance.
Based on calculations by mortgage consultant Chris Sykes we were able to work out the implications of having large amounts of unsecured debt.
For example, consider a family with three teenage children. The mother and father are in their forties both earning £40,000 each.
If they have no commitments, they could potentially borrow £400,000.
However, if that same family has a car on finance at £350 a month and also had to take a personal loan out during the pandemic to cover costs, costing them an additional £350 a month, then their potential borrowing, is reduced to £341,000.
This may force the family to rely on specialist lenders in order to achieve their required borrowing amount. This will almost certainly mean higher interest rates.
Having car finance may reduce you can borrow when it comes to applying for a mortgage.
The cost of being bumped into sub-prime mortgages
Those who have a credit file showing defaults, debt management plans, payday loans and county court judgements will very likely also be forced into the specialist lender camp. This is the area of the mortgage industry commonly referred to as sub-prime.
We asked Sykes to spell out the likely rate difference between a mainstream lender and a specialist one.
‘It is very dependent on a customers specific circumstances,’ said Sykes, ‘but if we compare a Natwest mortgage covering 75 per cent of a property’s value on a 2 year fixed rate that may be around 1.68 to 1.95 per cent.
‘If you go to a specialist adverse credit lender then that same situation could mean paying between 4.74 per cent and 6.15 per cent depending on how bad the adverse credit is.
‘If the adverse credit isn’t that bad it may be still possible with a mainstream lender or with a more specialist lender paying about 3 per cent.’
How to increase your chance of getting a mortgage
Applying for a mortgage can feel a little overwhelming, particularly given all the jargon and deals available.
Every mortgage lender has their own criteria which you may or may not be suitable for. On top of affordability and debt there are other factors that could cause you to be rejected.
For example, if you’ve just started a new job, some lenders will reject those still on probation, so it’s important to check this prior to submitting an application.
Those currently on a visa need to also check whether their lender only accepts applicants with indefinite leave to remain.
Unless you are determined to go it alone, contacting a mortgage broker would be a sensible approach.
They will also be able to interpret the impact of any blotches on your credit file.
David Hollingworth, associate director at L&C mortgages said: ‘It’s easy to get hold of your credit file from the credit reference agencies for little or no cost.
‘This will help your adviser to address any potential problems upfront rather than try to apply for rates that are never likely to be on offer.
‘Taking advice will help you to pinpoint the right deal which may allow affordability to be assessed across the market.
‘That could result in a mainstream rate being available rather than having to look to more specialist options, although advisers and brokers will be able to dig out those options where appropriate.’
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