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What has happened?

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 FCA’s recommendation addressed to mortgage lenders on affordability testing, which was revised in June 2017, stated :

‘When assessing affordability, mortgage lenders should apply an interest rate stress test that assesses whether borrowers could still afford their mortgages if, at any point over the first five years of the loan, their mortgage rate were to be 3 percentage points higher than the reversion rate specified in the mortgage contract at the time of origination (or, if the mortgage contract does not specify a reversion rate, 3 percentage points higher than the product rate at origination). This recommendation is intended to be read together with the FCA requirements around considering the effect of future interest rate rises as set out in MCOB 11.6.18(2). This recommendation applies to all lenders which extend residential mortgage lending in excess of £100 million per annum’.

At its September 2017 meeting, the FPC confirmed that the affordability test recommendation did not apply to any remortgaging where there is no increase in the amount of borrowing, whether done by the same or a different lender.

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 would therefore be simpler and more predictable. It would also reduce the impact on a small proportion of borrowers, while the wider assessment of affordability required by the MCOB responsible lending rules would remain as an appropriate affordability check. The FPC, therefore, decided to consult on withdrawing the affordability test recommendation

What are the key points of the withdrawal of the affordability test recommendation?

The FPC reviews its recommendations regularly and in its review, published in the December 2021 Financial Stability Report, it announced that it intended to consult on withdrawing the affordability test. The FPC judged that, on current evidence, the LTI flow limit, without the FPC’s affordability test recommendation, but alongside the wider assessment of affordability required by the FCA’s Mortgage Conduct of Business (MCOB) responsible lending rules, ought to deliver the appropriate level of resilience to the UK financial system, but in a simpler, more predictable and more proportionate way.

In its February 2022 Consultation Paper, the FPC sought views on its proposal to withdraw the affordability test. Following this consultation, it decided to withdraw the affordability test recommendation with effect from 1 August. 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.

How can we help you?

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.