There are fears house prices could continue to soar if existing mortgage affordability test rules are scrapped. If the lending rules are removed, more borrowers will be eligible for mortgages worth more than 4.5 times their salary.
Let’s take a look at what it all means.
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House prices: what are mortgage affordability rules?
Mortgage affordability test rules were introduced by the Financial Conduct Authority (FCA) in 2014. The rules essentially limit the number of mortgages banks can issue to borrowers that exceed 4.5 times their income.
The rules also include a Financial Policy Committee (FPC) affordability test. This requires lenders to determine the chances of a borrower being able to repay their mortgage. Importantly, lenders must also consider affordability if rates shoot up by 3% above the ‘mortgage revision rate’.
It’s widely agreed that the rules were put in place to limit the chances of people falling into negative equity, for example, following a fall in house prices or a hike in mortgage rates. The rules were also created to encourage banks to lend more sensibly.
In years gone by, banks have been accused of being overly liberal with lending. It’s thought that mortgages granted to borrowers who could not afford them contributed to the 2008 global financial crash.
While a number of banks were bailed out for their failings in 2008, rule changes helped to curb loose lending. This is because, prior to stricter lending criteria being introduced, it was often argued that banks weren’t incentivised to ensure borrowers could truly afford to repay their mortgage, particularly if times got tough.
What will be the impact of scrapping affordability rules?
With affordability rules on the verge of being scrapped, it’s possible that bigger mortgages will become the new normal. This could push up house prices.
Sarah Coles, senior personal finance analyst at Hargreaves Lansdown explains this fear, but also suggests that the Bank of England has done its own calculations. She says: “Letting people borrow more money looks like a risky move at a time when house prices are sky high and the outlook is uncertain. But the Bank is convinced the extra test isn’t fair anymore, and that without it, there are still enough protections in place.
“The FPC’s affordability tests have seemed increasingly draconian over time, because they refer to reversion rates – the mortgage rate you’re moved to at the end of your deal – and insist you should still be able to afford your mortgage if your rate rose to 3 percentage points above your reversion rate.
“Despite mortgage rates dropping dramatically in recent years, reversion rates have remained remarkably sticky, so in order to qualify for a cheap mortgage, buyers need to prove they can afford a really expensive one.”
Coles goes on to explain how rule changes could increase the risk of borrowers falling into negative equity. She explains: “The worry is that [affordability rule changes] could mean more people are able to borrow more money, which could make them vulnerable to over-stretching themselves to afford sky-high prices.
“Any weakness in the property market in the coming months could add the risk of negative equity for those who have borrowed much more. However, the Bank calculates that a combination of the FCA’s affordability rules and its own rule that limits the number of mortgages with a high loan-to-income will offer enough protection.”
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Will house prices continue to soar in 2022?
We know that house prices have climbed by roughly £25,000 over the past 12 months or so. However, the Bank of England insists that the removal of affordability rules won’t stoke the house price inflation fire.
Despite this, it’s difficult to understand how the invite to take out bigger mortgages won’t contribute to increased house prices. That’s because, aside from a shortage of properties, access to credit has a huge influence on house prices.
Of course, only time will tell how any rule changes will impact house prices in the real world.
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