Mortgage Affordability Stress Test Harder

Mortgage Affordability Stress Test Harder.

Financial Stability Report

The Bank of England has today published its 6 monthly Financial Stability Report.  Fundamentally, this is about issuing guidance to Banks regarding capital, borrowing, credit and market stability risks to enable them to prepare for any global or local economic change that may make banks financial unstable.

The mainstay of this report was today with debt exposure, in particular China increasing debt issue.  Much of the Worlds debt financing, particularly in European is underwritten in UK and Foreign banks based the City.  There are therefore two risks, China obviously and then Brexit may affect banking group positions if a EU trade agreement is not reached.  The regulator, the Financial Conduct Authority (FCA) has already asked banks to provide their contingency plans for various UK/EU Brexit scenarios.

More Capital Buffers for Banks

The Bank of England last year relaxed capital buffer requirements for Banks after the Brexit vote.  It is now changing position and starting to plan for global economic changes and possible downturns with the Bank of England now requiring banks to raises their Counter-Cyclical Capital Buffer (CCB) from 0% to 0.5% now  i.e. they need to set £5.7bn in accessible capital now and up again by another 0.5% to 1% in November 2017, another £5.7bn, meaning a capital buffer in place on £11.4bn.

Our comment:  we don’t think this is enough.

So what affects you, the consumer?  Mortgages.

Roughly 80% of all mortgages in the UK have deals that end within the next 5 years and with increased interest rates potentially increasing, there is a need to plan to ensure affordability and reduce repossession numbers if you then cannot re-mortgage onto a cheaper rate or you can no longer afford any future higher interest rate payments.

Consumer borrowing is already 10% higher than it was last year, so Banks are being asked to tighten up on their lending criteria, more has been borrowed on credit, more people are paying for cars on credit and ever increasing mortgage loans are required.  Currently there is only a guide that banks should not lend more than 4.5% X joint income and that a stress test on mortgage affordability should be around 3% pa over the mortgage lender’s standard variable rate (SVR) i.e. the rate that the mortgage payments would move to when any special period, discount or fixed rate ends.  This is merely guidance currently it is not a requirement.  Lenders are free to set their own affordability limits.  This is now to become a requirement.

The Bank of England now say lenders must include a 3% pa increased interest rate stress test - so you could be tested for mortgage affordability on rates as high as 7% or 8% pa.  IN addition, a maximum 4.5 X income should be used.  Could you afford it?

We have done our own research on mortgages with the highest SVR for a normal 75% loan to value mortgage, with no adverse conditions, at 5.64% pa and the lowest at 1.95% pa.  Meaning under a stress test for your mortgage application, whilst rates are lower today, you could be tested to see if you can afford your mortgage if it increased to 8.64% pa.  Even taking the median rate at 3.80%, this means a stress test for a mortgage at 6.80% pa.

Example:

A 25 year term, £100,000 capital and interest repayment mortgage at a discount rate of 2.5% pa would initially cost today £448.62 per month.

If the SVR was 3.80% pa, at the end of the discount rate, the monthly mortgage payments £516.86 per month.

Add the stress test to this, the mortgage rate would be 6.80% pa, meaning a monthly mortgage cost of £694.07 per month. 

That’s nearly £250 pm more, could you afford it?    What if you borrow £150,000 or £200,000 or even more?  This could be a big whole in your budget.

The problem is that many of us have got used to low rates and many cannot remember or where not even born when interest rates were over 15% pa on a mortgage.

Expect mortgage underwriting to get much tougher over the next few years.