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Bank of England poised to loosen mortgage lending rules

·3-min read
A view of an estate agents in London
A view of an estate agents in London

The Bank of England is poised to loosen mortgage lending rules introduced in the wake of the financial crisis, in a move economists have warned risks sparking a housing bubble.

Officials are understood to be considering softening affordability checks for borrowers as part of a review of the market restrictions that concludes next week.

One of the measures being looked at is reducing the additional interest rate charge used to test borrowers’ ability to pay the reversion rate after an initial deal ends.

This would benefit first-time buyers, as tight rules designed to protect them against a return to old fashioned high interest rates has made it harder for some would-be homeowners in an era of apparently permanently low borrowing costs.

Tighter checks were brought in in 2014 to try to stop a repeat of the crisis.

However, economists warned that relaxing the lending rules risked creating a housing bubble by propelling property prices to “unsustainable levels”.

House prices soared 12pc in the 12 months to September, growing at a faster pace than the run-up to the financial crisis after being boosted by the stamp duty cut. Nationwide warned last week that house sales in 2021 are also close to levels last seen in 2007, just before the property market crash.

Andrew Wishart, housing economist at Capital Economics, said: “Loosening the affordability test increases the chances that you continue to get large increases in house prices, which would start to make us worry about the housing market entering bubble territory.

“It would help perpetuate very strong demand that might take prices to an unsustainable level.”

Mr Wishart warned prices could suffer a “correction” and slump if growth continues at its current rapid pace.

He said: “This is exactly the time when we probably want that affordability test to make a difference and slow down the most stretched lending a little bit, and cool things off a little.”

Lenders have to check homebuyers can afford repayments once any initial interest rate deal ends by testing their ability to pay the reversion rate. This is typically their bank’s standard variable rate (SVR), plus three percentage points. This is designed to make sure borrowers are not too vulnerable to higher interest rates in future.

However, interest rates have stayed at rock bottom levels for far longer than officials anticipated when they brought in the rules, while a rise in the base rate to 3pc now seems outlandish.

At the same time, SVRs have held steady at between 3.6pc and 4.6pc over the past decade, even as initial rates on mortgages have plunged, making the test tougher than was initially expected.

As a result, the Bank of England is looking at softening the affordability check, potentially reducing the additional interest rate charge from its current level of three percentage points.

Martin Beck at the EY Item Club said the move would be “odd given how loose mortgage lending has been – it has not been hard to get a loan”.

But he added that changing the rules after the stamp duty holiday has ended means officials are “not adding fuel to the fire; they are supporting the market at a time when headwinds are building”.

Kallum Pickering at Berenberg Bank said changing the rules could be proportionate, as banks have built up larger capital buffers in the years since the financial crisis, meaning they can withstand losses from risky loans without cutting back on lending to the rest of the economy.

At the same time, households are not heavily indebted by historic standards, with many building up significant savings over Covid lockdowns.

David Hollingworth, at brokerage L&C Mortgages, said the rules bite particularly for first-time buyers who typically have to accumulate a large deposit and then stretch to get a large mortgage to get onto the housing ladder.

Officials are also reviewing the rule which limits lending to buyers borrowing more than 4.5-times their income.

Currently such large loans can make up no more than 15pc of a bank’s total loanbook.

The Bank of England declined to comment.

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