Mortgage ‘stress tests’ are too tough, say lenders
5 per cent rate is too high, says Council of Mortgage Lenders chief
Regulators should reduce the “stress test” interest rates applied to mortgage borrowers to judge whether they can afford a home loan, since they are “locking people out of the market” at their current level, lenders and brokers said.
Under rules brought in by the Bank of England’s Financial Policy Committee (FPC) in 2014, lenders are required to assess whether borrowers could still afford their mortgage if base rates were three percentage points above their current level at any point over the first five years of the loan. Once lenders include their margins, stress rates typically hit 5 per cent and above.
Peter Hill, chairman of the Council of Mortgage Lenders (CML) and chief executive of Leeds Building Society, said regulators should look again at these hypothetical rates of interest given the shift in economic circumstances since the rules were introduced.
“The question I would ask is can we foresee rates over five years being at that level? It feels quite unlikely,” said Mr Hill. “Is this stress rate realistic in the current environment — because it’s locking people out of the market.” He said he was not speaking on behalf of the CML but in a personal capacity.
Mr Hill said the requirement had been laid down at a time when there was serious concern among regulators and the government that the housing market was overheating. Annual house price growth in London, where activity was at its most pronounced, hit 20.1 per cent in the year to May 2014, according to figures from the Office for National Statistics.
However, the annual growth rate in London had since fallen back to 8.1 per cent in the latest ONS figures (direct comparisons between the figures are qualified, since in June 2016 the ONS index was merged with the Land Registry house price index). Across the UK, prices rose by 6.7 per cent in the year to November, and the Bank of England cut interest rates to a new record low last summer.
The FPC defended the calibration of the affordability test as recently as November, when it said in its review of financial stability that the 3 per cent level “remains proportionate”.
“The market-implied path for Bank Rate has fallen since 2014,” it said. “But the FPC judges that, given the long-term nature of mortgage contracts, it would be imprudent to rely too heavily on potentially volatile market-implied measures of future interest rates. In addition, the current calibration of the affordability test strengthens resilience in the face of adverse income and unemployment shocks.”
The stress rate minimum applies only to the first five years of a mortgage, so fixed-rate deals for five years or longer are officially exempt. In practice, however, brokers said lenders were applying the same affordability tests to all mortgage applicants regardless of the length of fix.
Adrian Anderson, director at broker Anderson Harris, said borrowers were incredulous when told that, though they were looking at taking out a ten-year fixed rate mortgage at around 2.5 per cent with base rates at 0.25 per cent, they were being stress-tested for affordability at 6.5 per cent.
The stress rates had a “particularly big impact” on older borrowers, he added. “If lenders are assessing a mortgage on a capital repayment basis until retirement age, a 50-year-old has 17 years to pay off the mortgage, stressed at 6.5 per cent. We need some stress test but it does seem to me and many clients that it is very high.”
David Hollingworth, director at broker London & Country Mortgages, said lenders were unwilling to differentiate their affordability tests based on the length of a fix because of the risk that customers would flock to the longer-term offers. “There’s an argument that everyone would lock into a longer-term fixed rate not because it was the right product for them, but because it opens the gate to a larger borrowing amount.”
There remained a case for the regulator to review stress rates regularly, he said, but there was likely to be little appetite today to trim them. “With higher inflation feeding through there will be some concerns about whether it is the right time to loosen the reins on stress testing,” he said.
Predictions about where interest rates would be over five years remain hard to call. “The flip-flopping in the last six months as to what base rates will do over that period has gone from a likely cut to the potential for a rate rise. The reality is that nothing has happened,” Mr Hollingworth said.