Mortgage affordability rules relaxed

The Bank of England has announced plans to relax mortgage lending rules from August 1 in a major boost for first-time buyers.

Borrowers currently have to show they would be able to afford repayments if their mortgage reverted to their lender’s higher variable rate and interest rates jumped by 3%.

But after consulting lenders and other members of the industry, the Bank’s Financial Policy Committee (FPC) has said it will scrap the rule this summer.

The change is great news for first-time buyers, who were most likely to have been caught out by the rule.

It comes at a time when rising interest rates and high house prices are already making it challenging for people to get on to the property ladder.

Why was this rule introduced?

A number of new affordability guidelines were introduced for lenders in 2014 to protect the banking system from high levels of debt following the financial crisis in 2008.

The FPC called on lenders to make sure borrowers could still afford their mortgage repayments when their fixed rate deal ended and if interest rates rose.

As a result, lenders had to make sure that monthly repayments were still affordable if borrowers were moved on to their reversion rate – typically known as the standard variable rate – and interest rates rose by 3%.

The FPC also asked lenders to limit the number of mortgages they offered to people borrowing 4.5 times their income to 15% of their total lending.

Why is it being scrapped now?

When the rule was introduced, interest rates were expected to rise to 2.25% in the coming five years.

When the FCA first launched its consultation around lifting the rule, it seemed highly unlikely that interest rates would hit this level in the years ahead.

As a result, the FCA thought the test was no longer needed.

But since then inflation has soared to a 40-year high of 9%, causing the Bank of England to raise interest rates five consecutive times to 1.25%.

While that is still well down on the 2.25% anticipated when the test was introduced, interest rates are now expected to rise to 3%, or possibly higher, next year.

The average standard variable rate is already just under 5%. If interest rates rise by a further 1.5%, borrowers would have to show they could afford a mortgage rate of 9.5%.

For example, if someone was borrowing £180,000 on a two-year fixed rate mortgage with an interest rate of 2.5%, their monthly repayments would be £815.

But they would have to prove that they could still afford their mortgage if the interest rate was 9.5% and their repayments were £1,590 a month – almost double the amount they would actually pay.

Such a tough test would exclude many people from taking out a home loan.

While the FCA has not commented on this issue directly, it is thought to be one of the reasons it is withdrawing the rule so quickly after the consultation concluded.

Officially, it has said that the rule limiting the proportion of customers who can borrow more than 4.5 times their income and other affordability checks are enough to ensure lending is responsible.

Who does it benefit?

The decision to withdraw the rule is good news for homeowners who have borrowed a relatively high proportion of their salary and would need to remortgage in the next few years.

It is particularly good news for first-time buyers, who typically have lower salaries and smaller deposits, making them more likely to struggle with the test.

Capital Economics estimates that when the stress test interest rate was 6.6%, the typical mortgage customer was able to borrow five times their income.

But if the rate used for the stress test hit 9.5%, the maximum amount they could borrow would drop to just four times their income.

Around one in four people currently borrow more than four times their income, so if the rule had stayed in place, many people would have struggled to get a mortgage.