Mortgage lenders are told they can scrap affordability rules. Here’s why it’s still important to assess your budget
Posted onThe Bank of England’s (BoE) decision to scrap some affordability tests for people taking out a mortgage could mean you’re able to borrow higher sums. However, it’s still crucial that you have confidence in your budget and don’t overextend yourself.
From 1 August 2022, lenders won’t have to carry out affordability tests that assess how buyers would cope if interest rates increased.
The decision has attracted some criticism given that interest rates are beginning to climb.
After more than a decade of very low interest rates, the BoE has slowly started to increase its base rate. It now stands at 1.25% and is likely to rise further.
There are concerns that the UK could face an economic recession and households could struggle as the cost of living rises.
However, the BoE has said that it will not withdraw the loan to income (LTI) flow limit. This limits the number of mortgages lenders can extend to borrowers at an LTI ratio of 4.5 or greater. The Bank said this, along with wider assessments of affordability, “ought to deliver the appropriate level of resilience”.
The Bank of England introduced the stringent affordability test after the 2008 financial crisis
The BoE introduced the affordability test, which it is now scrapping, in 2014. It was intended to make sure borrowers did not take on more debt than they could afford and end up “amplifying” a downturn, as happened in 2008.
In 2007, the “credit crunch” was driven by a sharp rise in defaults on sub-prime mortgages. These mortgages, normally issued to borrowers with lower credit ratings, were mainly in the United States. However, the effects spread throughout the world and triggered a global recession in 2008.
According to a report published in the Guardian, repossessions in the UK hit a 12-year high in 2008. Around 40,000 repossessions happened in 12 months, and the high levels continued into 2009.
Growing unemployment and buyers overextending themselves in the days of easy credit – when 125% mortgages were available – contributed to the number of repossessions.
The BoE’s stringent affordability tests were designed to prevent this from happening again, by ensuring that most borrowers could meet repayments.
How will scrapping the affordability test change what you can borrow?
Scrapping the affordability test doesn’t automatically mean lenders will change how they review applications or that you can borrow more.
Lenders still have a duty to lend responsibly. They will also have their own criteria to ensure they’re not taking too much risk by increasing the amount of credit they offer or the people they approve applications from.
However, it could mean you’re able to borrow more than you could before, and some lenders may be more flexible. If you have a good credit score and can demonstrate you’ve reliably paid rent for years, you may find that a lender will now approve your application that was previously rejected.
If you’ve struggled to secure borrowing in the past or affordability tests mean you delayed plans, the change could be good news.
Working with a mortgage broker can help you identify the lenders that are most likely to approve your application. These could be lenders that don’t have a high street presence and you may overlook them if you’re applying for a mortgage alone.
We’re here to offer support and advice if you have any questions about how the changes could affect your goal to buy a home.
Homebuyers should still carry out their own affordability tests
Just because a lender says you can borrow a certain amount, doesn’t mean you should take out a mortgage of this size.
You should still consider how it’ll fit into your budget and other plans you may have. If taking out a mortgage for the maximum amount could mean you’d struggle financially, opting for a lower figure can make sense. It means you can have confidence that you’ll be able to make repayments now and in the future.
Spending some time reviewing your income and outgoings to conduct your own affordability test can mean you’re more financially secure.
Keep in mind that interest rates are rising. If you take out a variable- or tracker-rate mortgage, the amount of interest you pay could increase during the mortgage term. So, you should give yourself some leeway when calculating your outgoings.
Do you want to discuss mortgages?
If you want to take out a new mortgage, whether to buy your first home, step up the property ladder, or borrow more, we can help.
We’re here to offer advice throughout the mortgage process and help you identify which lenders are right for you. Please contact us to discuss your needs and speak to one of our team.
Please note: This blog is for general information only and does not constitute advice. The information is aimed at retail clients only.
Your home may be repossessed if you do not keep up repayments on a mortgage or other loans secured on it.
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