FPC maintains LTI flow limit, saying it is more effective
The Bank of England (BoE) has announced that it will withdraw its mortgage market affordability test recommendation effective August 01, 2022.
In 2014, the BoE’s Financial Policy Committee (FPC) began subjecting borrowers to two tests when taking out mortgages. These were meant to “guard against a loosening in mortgage underwriting standards,” which, in turn, could lead to a material increase in aggregate household debt.
One of the two tests, the affordability test, specifies a stress interest rate for lenders when assessing prospective borrowers’ ability to repay a mortgage. It requires a borrower to be able to afford their mortgage if the interest rate went three percentage points higher than the reversion rate.
The other recommendation, the loan to income (LTI) ‘flow limit’, which the BoE will not withdraw, limits the number of mortgages that can be extended to borrowers at LTI ratios at or greater than 4.5.
In its latest review, published in the December 2021 Financial Stability Report, the FPC judged that the LTI flow limit is likely to play a stronger role than the affordability test in guarding against an increase in aggregate household indebtedness and the number of highly indebted households in a scenario of rapidly rising house prices.
In February 2022, the FPC launched a consultation on withdrawing the affordability test while maintaining the LTI recommendation.
The majority of responses, FPC revealed, were supportive of the proposals to withdraw the affordability test and maintain the LTI flow limit.
Still, Gemma Harle, managing director at Quilter Financial Planning, believes that the timing of the BoE announcement that it is going to loosen its affordability rules is somewhat baffling and may enrage some who still have the financial crash burned into their memory.
“With interest rates starting to creep up to meet the damaging impact of inflation and soaring energy and food prices you would think that people’s ability to afford their mortgage should really be under the spotlight now,” Harle said.
“However, this move by the Bank of England may illustrate that the long-term health of the housing market is predicted to be less than rosy, and this change is a means to guard against a real slump in house prices.”
Harle pointed out that while it is potentially bad timing for the announcement, the change in the affordability rules may not be as significant as it sounds as the LTI ‘flow limit’ will not be withdrawn, which has much greater impact on people’s ability to borrow.
FPC also said that lenders do not need to make any changes as a result, as current affordability assessments ought to be compliant already with the FCA’s MCOB framework.
According to Harle, although the shift in rules is one of the many attempts to help first-time buyers get their foot on the ladder, it may end up having the opposite effect.
“House prices have become further and further out of reach for prospective buyers and this change in the affordability rules could perpetuate unsustainable further growth as it steps up demand in a market already suffering with limited stock,” she pointed out.
“Ultimately, one of the key strategies the government should adopt to help first-time buyers on to the ladder is simply to build more stock. This has a natural effect of stabilising house prices and bringing them down due to the laws of supply and demand. This will be the only way of really helping the masses get on to the housing ladder.”