Affordability calculations

The Bank of England’s Financial Policy Committee could be set to change the way it assesses affordability of mortgages.

2014 changes to mortgage underwriting

In 2014, the Financial Policy Committee (FPC) introduced two new safety nets, to guard against household debt, when it came to mortgage underwriting.

These changes were:

  • The ‘Loan to income (LTI) flow limit’, which refers to the number of mortgages lenders could offer at a loan to income ratio of more than 4.5 times the applicant's income.
  • The ‘affordability test’, which sets a ‘stress rate’ used in the calculation, which helps to establish if the mortgage remains affordable if the mortgage interest rate were to increase.

A conversation was begun in December 2021, where the FPC considered rising house prices and ways they could avoid the increase in financial stability risks if there was a material increase in household indebtedness.

The analysis suggests the affordability test could have caused around 6% of borrowers to take out smaller mortgages than they would have been able to in the test’s absence.

According to a report published by Mortgage Broker Tools, the average maximum loan in January was £421,053. This is a £20,000 increase in just a month.

The figure also represents a 13% increase when compared to the average from January last year.

Is mortgage affordability testing set to change?

The FPC has judged recently that the LTI flow limit, alongside the wider assessment of affordability required by the FCA’s Mortgage Conduct of Business framework, could deliver an appropriate level of support when it came to preventing household debt.

Therefore, the Committee has decided to maintain the LTI flow limit recommendation and to open a consultation on withdrawing its affordability test recommendation.

The consultation will focus on the following:

  • What impact is the affordability test recommendation currently having on the mortgage market?
  • How would lenders and the mortgage market respond, if the recommendation were withdrawn?
  • What effect withdrawing the recommendation may have on the housing market as a whole and on particular segments of the market?

The current position on buy to let affordability calculations

Buy to let mortgages are subject to an affordability test, which stresses both the rate of borrowing (stress rate) and the amount the rent exceeds the mortgage payment (loan to income rate). This calculation seeks to ensure that the mortgage remains affordable to a landlord, if there was a change in the rate or some other financial instability were to occur – for example, the tenant being unable to pay rent.

What does this mean for landlords?

The discussions relate to the residential mortgage market, however, if a change were to come about, might this extend to the buy to let market?

Landlords may be able to borrow more if the ‘affordability test’ was removed, as some lenders use an assessment of personal background income, as well as rental income. These changes may see these lenders be able to increase the loan amount they can offer.

It seems incongruous that a change of this type would be made, given that since 2014 the overriding direction of travel was to tighten mortgage affordability assessments.

Until a final conclusion is drawn from the FPC consultation, the whole subject is very much up in the air.

The consultation, which can be found here, closes on the 6th of May 2022. If a decision is taken to withdraw the affordability test, it would be expected to take effect within a year.