Stringent new rules on mortgage affordability could force borrowers to prove that they could afford repayments almost twice as high as the expected monthly cost of their loan.
The Bank of England announced the beefed-up rules on affordability or "stress tests" in its Financial Stability Report, published yesterday.
We explain the likely effects of the changes.
What is changing?
The Bank is keen that lenders do not get lulled into a false sense of security by current low interest rates and offer increasingly risky loans. The report points out that mortgage debt has historically been a source of risk in terms of financial stability.
The new rules force lenders to apply an interest rate stress test - a test of a borrower’s ability to weather increases in the mortgage rate - at 3 percentage points above the rate that will apply when the introductory offer ends.
Such "reversion" rates are often the same as the lender's standard variable rate, or SVR. According to Ray Boulger of John Charcol, the broker, SVRs can currently be as high as 5.75pc. This could mean that some banks are forced to stress test at a very high rate of 8.75pc.
Will this make getting a mortgage harder?
Some borrowers will now find it harder to get a mortgage. Ian Gordon, a banking analyst at Investec, the specialist bank, said some “at the margins” might see their affordability shrink.
Analysis by London & Country, the mortgage broker, found that someone who made monthly payments of £766 on a 25-year £200,000 mortgage could have to prove that they could afford repayments of £1,478 at a rate of 7.5pc.
The previous stress test would have checked affordability at 5pc, equivalent to repayments of £1,169, so the extra amount that borrowers would have to prove they could afford would be £300 a month.
But David Hollingworth, a director at the broker, said the rule change did not mean the industry would change overnight.
“Larger lenders won’t be seeing this as a radical change,” he said. “It will mean they won’t be able to consider loosening their stress test if they think competition is edging ahead. That’s what this report is all about.”
A £300 rise in provable payments sound a lot. Why are lenders relaxed about the change?
On the face of it, having to prove that much larger repayments are affordable is a significant stumbling block for many borrowers, who may be perfectly able to afford an initial interest rate of 1.5pc but would struggle at 8pc.
But analysts said lenders had already been stress testing at this level since 2014, when the Bank introduced it as a recommendation.
Mr Gordon said: “Many banks with high SVRs are already implementing stress testing at this level. But there will be exceptions to the rule and if you look hard enough you will find banks with high SVRs and lower stress testing rates that will be heavily affected.”
Some borrowers could even benefit
Mr Boulger said some buyers in niche areas such as shared ownership mortgages could actually be offered better deals as a result of the rule change.
He said many of the smaller lenders could be forced to focus on niche markets, such as mortgages for the self employed, because the rules would make them uncompetitive for mainstream borrowers.
This could lead to greater competition in the niche areas.
What about buy-to-let mortgages?
There is no immediate change to the buy-to-let market as a result of the Bank of England's report. While those mortgages are stress tested at a lower rate than owner-occupier mortgages, the changes to tax relief and affordability tests announced by George Osborne in 2015 are more significant.
Buy-to-let investors are now required to prove that rental income will exceed 125pc of the mortgage costs, or 145pc for higher earners. The Bank’s current advice to lenders is to stress test at the higher of 5.5pc or a 2 percentage point increase in buy-to-let mortgage interest rates.