Bank of England reveals plan to relax mortgage affordability rules

The Bank of England has announced plans to relax mortgage lending rules.

At the moment, borrowers have to show they’d be able to afford the repayments if their mortgage reverted to their lender’s higher variable rate and interest rates jumped 3% .

This test is designed to check buyers could still meet mortgage payments if rates went up.

But the Bank’s Financial Policy Committee (FPC) has decided this affordability rule is no longer needed.

It will consult mortgage lenders and other industry parties early next year about withdrawing the 3% interest rate rule.

The change is likely to offer better mortgage opportunities to first-time buyers.

Why are mortgage affordability rules being eased now?

A number of new affordability guidelines were introduced in 2014.

This idea was to protect the banking system from high levels of household debt following the financial crisis of 2008.

At that time, the FPC recommended that lenders limit the number of mortgages they offered to people borrowing 4.5 times their income.

It also asked lenders to make sure borrowers could afford their mortgage repayments when their fixed-rate deal ended.

This calculation was based on interest rates increasing by 3%, and borrowers being moved on to their lender’s “reversion rate” or higher standard variable rate, which is typically 4.5% or higher.

The reforms were introduced when interest rates were expected to rise to 2.25% in the coming five years.

Today, the Bank of England base rate currently stands at 0.25%.

While interest rates are expected to rise next year, they are likely to do so at a much slower rate than previously expected.

Meanwhile, the FPC has decided other limits on how much banks can lend to people are enough to protect financial stability.

This includes limiting the number of mortgages given to people borrowing a high multiple of their income to just 15%.

Who does the change in mortgage affordability rules affect?

The end of the higher standard variable plus 3% interest rate affordability rule is great news for first-time buyers.

The fact that people buying their first home typically have lower salaries and smaller deposits meant they were more impacted.

For example, a borrower applying for a two-year fixed rate mortgage with interest charged at 1.99%, would have to show they could still afford repayments if the interest rate was 7.5%.

While monthly repayments on a £160,000 mortgage at 1.99% are £682, they would nearly double to £1,196 if the rate was 7.5%.

The rule led to thousands of borrowers being told they could not afford a mortgage, even though they were never likely to face repayments at such high interest rates.

The changes are likely to mean more first-time buyers make it onto the ladder in 2022.

But, the announcement was not all good news for first-time buyers.

The FPC has decided to keep limits in place on the number of high loan-to-income mortgages lenders can provide to borrowers.

Mortgages are getting cheaper for first-time buyers 

More good news for first-time buyers is that the average cost of a mortgage for people with only a 5% deposit has fallen to a record low.

The typical cost of a two-year fixed rate mortgage for someone borrowing 95% of their home’s value fell for the eighth month in a row in November to 3.09%.

Meanwhile, the cost of a five-year fixed rate deal dropped to 3.39%.

Both rates are the lowest financial information group Moneyfacts has recorded since records began in 2011.

The number of different mortgages available to all borrowers has reached the highest level since 2008.

Homeowners now have more than 5,300 different deals to choose from.

This includes more than 700 mortgages for borrowers with deposits of 10% or less.

First-time buyers struggled to get a mortgage in 2021

This year saw plenty of first-time buyers have their mortgage applications rejected by banks or building societies.

Only 35% of first-time buyers had their first mortgage application approved in 2021.

This is compared with 48% who were approved first-time in March 2020, according to research by specialist lender Aldermore.

The reasons buyers were turned down for a mortgage included:

• a poor credit history
• administrative errors
• not having a large enough deposit.
• having taken out a payday loan
•  being self-employed
• having an irregular income
• a high level of debt.

Buyers surveyed blamed the situation on the Covid-19 pandemic.

Half of those surveyed had experienced disruption to their employment, such as being furloughed or made redundant.

While 2022 looks set to offer more mortgage opportunities, buyers will still need a good credit score.

What else is happening in the mortgage market?

Mortgage lending looks set to reach a record high in 2021.

This is on the back of high levels of housing market activity caused by the pandemic-induced search for space and stamp duty holiday.

Lenders are expected to have advanced a total of £316bn-worth of mortgages during the year.

That’s 31% more than in 2020, according to mortgage industry body UK Finance.

The prediction is in line with our own data that estimates one in every 16 properties will change hands this year.

We’ve seen the busiest property market for 14 years, and the increase in activity has not just been seen among homeowners.

Lending to buy-to-let landlords soared by 83% year-on-year to £18 bn, the UK Finance figures showed.

The private rental sector currently faces a significant mismatch between supply and demand.

A shortage of homes to rent has been putting upward pressure on the cost of renting.

The cost of renting a home in the UK outside of London is now £809 a month on average.

But the increase in buy-to-let lending revealed by UK Finance suggests landlords have been buying more homes this year.

An increase in supply will potentially mean less competition for rentals, which could moderate rental costs.