The Financial Policy Committee (FPC) of the Bank of England has made two important announcements today:
“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, Bank Rate were to be 3 percentage points higher than the prevailing rate at origination.
The PRA and the FCA should ensure that mortgage lenders limit the proportion of mortgages at loan to income multiples of 4.5 and above to no more than 15% of their new mortgages.”
In addition, the Treasury has today announced that no new loans under the Help to Buy Mortgage Guarantee scheme (HtB2) can be “at or above 4.5 times borrowers’ income”. The Help to Buy Equity Loan (HtB1) scheme already has a 4.5X income cap. The average income multiple to date for HtB2 has been 3.1, with less than 5% of loans at LTI ratios at or above 4.5.
On the first measure, following the Mortgage Market Review (MMR), the Bank says most lenders are using a stress test rate of around 2½% to 3% above current standard variable rates of around 4-4½%. Because the new stress-test rate of 3% is “broadly in line with the current practice by most major lenders, the FPC expects the incremental impact of this guidance on mortgage lending to be relatively small”, although “individual lenders may need to enhance their current practices to meet this recommendation”.
Under the rules, introduced on 26th April, lenders have been expected to stress test borrowers on their ability to meet their mortgage payments over a five-year period not just at current mortgage rates, but also with reference to expected future levels based on market expectations. Today’s announcement introduces a more prescriptive rule.
Lenders are expected to take account of the second measure immediately. (It applies to lenders which extend residential mortgage lending in excess of £100m per annum.) However there is a consultation (released today) so that the formal implementation date will not be until 1st October 2014.
On the Bank’s central forecasts for the housing market, it expects the share of new mortgages at LTIs at or above 4.5 to be around 15%, in line with the limit announced today. However were the housing market to follow the Bank’s “upside housing scenario” (i.e. higher mortgage approvals and house price inflation rising to around 15%), the Bank predicts LTIs of 4.5 or above would rise to 25% of new loans, so the new 15% cap would have a material impact.
The Financial Stability Report says:
“New mortgage lending to borrowers with higher loan-to-income (LTI) multiples has increased more significantly [than high loan-to-value- (LTV) mortgages]. While the proportion of new mortgages to borrowers with an LTI multiple above 5 has been stable, the proportion to borrowers with an LTI multiple greater than 4 rose to 22% in 2014 Q1. That exceeded the former peak in 2007. And the proportion of mortgages to borrowers with LTI multiples greater than 4.5 has risen to 11%. Within this, LTI multiples are particularly high among borrowers purchasing high-value properties and properties in London.”
The Report adds:
“In the four quarters to 2014 Q1, around 10% of lending for house purchase was extended to an LTI at or above four and a half times income; this compares to 6.5% in the immediate pre-crisis period, 2005-07.”
The Bank comments on the two FPC measures:
“These measures are not expected to have a material impact on mortgage lending and housing transactions in the near term.” On its central forecasts scenario for the housing market, “the impacts of the FPC’s policy measures are likely to be minimal”.
The measures are an insurance policy, or pre-emptive strike, to “guard against the risk of a build-up of excessive household indebtedness if the underlying strength in the housing market turns out to be greater than expected.”
The FPC has a range of policy tools at its disposal. The fact that the stress-test rate announced today is in line with current practice, and so is not expected to have any significant impact, and that the 4.5+ LTI share of mortgages will be limited to 15% of new loans, in line with current Bank expectations under its central housing market forecasts, shows today’s exercise is an insurance policy – described by one commentator as “future proofing” - against future financial risk. In the words of the Financial Stability Report:
“The FPC does not believe that household indebtedness poses an imminent threat to stability. But it was agreed that it is prudent to insure against the risk of a marked loosening in underwriting standards and further significant rise in the number of highly indebted households.”
It is notable that because high LTI mortgages are more common in London, the limit on LTI new lending may have more impact on the London market where fears of a bubble are greatest.
It is also worth noting that all the statistics quoted above pre-date the MMR changes (introduced on 26th April, although adopted earlier by some banks). The MMR rules will already have caused some tightening in lending even before today’s announcements.
If the housing market is stronger than the Bank expects, both new measures will tend to curb higher-risk lending. The FPC could also introduce additional measures.
In addition to the measures announced today, the UK banking sector is undertaking a stress-test exercise, to be completed by the end of 2014, which will assess the resilience of the UK banks to a market fall in house prices and substantial increase in interest rates. The stress test will require banks to assume “house prices and commercial real estate prices fall by around 35% and 30% respectively”.
John Stewart Director of Economic Affairs
Home Builders Federation
London, SE1 9PL
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