Borrowers are subjected to two tests when taking out mortgages which were introduced by the Bank of England’s Financial Policy Committee (FPC) in 2014.

One is the affordability test which specifies a stress interest rate for lenders when assessing prospective borrowers’ ability to repay.

It tests whether a borrower could still afford their mortgage if at any point over the first five years of the loan, the mortgage rate was to be three percentage points higher than the reversion rate.

This affordability test has been withdrawn as of Monday 1 August 2022 by the FPC as it looks to maintain the second test: the loan to income (LTI) limit. This puts a restriction on how many mortgages a lender can issue at LTI ratios of 4.5 times income or greater. 

A consultation was published in February this year, with the FPC confirming its decision in June to remove the affordability test, effective from August. The FPC concluded that the LTI flow limit would play a stronger role than the affordability test in guarding against a rise in household indebtedness.

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It said with the removal of the stress test, the LTI flow limit alongside wider mortgage affordability assessments required by the Financial Conduct Authority’s (FCA’s) responsible lending rules (Mortgage Conduct of Business MCOB) would “deliver the appropriate level of resilience to the UK financial system, but in a simpler, more predictable and more proportionate way”. 

It continued: “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.” 

In February, the FPC consulted to remove the stress test and maintain the LTI flow limit and found the majority of responses supported the proposal. The 27 respondents included four trade bodies which represent the mortgage providers and intermediaries, individual organisations, lenders of different sizes, third sector organisations and members of the public.

Lenders do not need to make any changes as a result of the change, the FPC said, as current affordability assessments should be compliant with MCOB. 

In relation to the notice period, it said a longer lead time could make borrowers delay applying for a mortgage, as reversion rates have increased since the consultation was launched. 

‘Baffling’ decision 

Speaking at the time the FPC confirmed its move to withdraw the affordability test, Gemma Harle, managing director at Quilter Financial Planning, said: “The timing of today’s announcement that the Bank of England 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. 

“However, this move by the Bank 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.” 

She said the change in rules may not “be as significant as it sounds” as the LTI limit had a greater impact on people’s ability to borrow.  

Harle added: “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. One of the main drivers behind ‘generation rent’ is the fact that house prices have massively outstripped wage growth.  

“Due to high house prices, first-time buyers also need very sizable deposits and in the current fiscal environment saving this type of money will be very difficult due to increasing rents and the cost of living. On top of this, inflation will be eating away at any other savings they have sitting in cash. 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.”