In 2014, the Bank of England’s Financial Policy Committee (FPC) introduced two recommendations to guard against a loosening in mortgage underwriting standards that could lead to a material increase in aggregate household debt and the number of highly indebted households; namely the ‘LTI flow limit’, which limits the number of mortgages that can be extended at loan to income ratios at or greater than 4.5, and the ‘affordability test’ which specifies a stress interest rate for lenders when assessing prospective borrowers’ ability to repay a mortgage.
The FPC has noted some concerns with how the affordability test has operated. In particular, the stress rate required by the test has remained broadly static, reflecting stickiness in reversion rates despite past falls in average quoted mortgage rates.
The FPC has examined the potential effect of both measures in a scenario of rapidly rising house prices, where, in the absence of policy measures, the risks from excessive household indebtedness would increase sharply. When comparing the effect of each individual recommendation in isolation, the FPC’s analysis suggests 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 when house prices rise rapidly. In addition, analysis suggests that the additional insurance provided by the affordability test is small. A framework without the FPC’s affordability test recommendation will therefore be simpler and more predictable. It will also reduce the impact on a small proportion of borrowers, while the wider assessment of affordability required by the MCOB responsible lending rules will remain as an appropriate affordability check. The FPC therefore consulted on withdrawing the affordability test recommendation and withdrew it on 1st August 2022.
The withdrawal of the FPC affordability test recommendation does not place any requirement on lenders to take action, as existing affordability assessment practices are subject to the FCA’s MCOB framework and will remain so. It will be up to individual lenders as to whether they wish to make any changes to their own lending practices, and to determine the timing of any such changes after this date.
The LTI flow limit remains in place and continues to guard against a deterioration in underwriting standards that could lead to a material increase in aggregate household debt and the number of highly indebted households by limiting lending at high LTI ratios.
The FPC has noted that the consultation feedback indicated that a period of two to three months might be needed for lenders to operationalise any changes that they may choose to make to their affordability testing. However, the FPC has also noted that the withdrawal of its affordability test recommendation does not place any new requirement on lenders to take action, as existing affordability assessment practices are already subject to the FCA’s MCOB framework and will remain so. If lenders choose to adjust their lending practices in response to the FPC’s withdrawal of the affordability test recommendation, feedback from the consultation suggested that any system or process changes were unlikely to be material to implement.
If you’d like to know more about how we can help you with your affordability assessment arrangements, or any other regulatory compliance issues, our specialist team is here to help.
Contact us today on 0207 436 0630 – or email info@thistleinitiatives.co.uk.