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July, 2019
Bank of England hints at potential relaxation of affordability rules

Bank of England has hinted that strict affordability tests could be relaxed, but only if house prices start to rise.

This prediction was made in a working paper “Modelling the distribution of mortgage debt”.

The paper looks at a number of factors, including the Financial Policy Committee’s measures – introduced in 2014 – to limit the availability of high loan-to-income (LTI) mortgages.

To do this it introduced two measures: first was an LTI flow limit that limited the proportion of mortgages with LTI ratios of 4.5 or higher to 15% of new mortgages.

The second was an affordability test for borrowers. This effectively required lenders to ensure the mortgage remained affordable with a 3 percentage point rise in interest rates.

The paper projects a number of different circumstances to see if this FPC policy needs changing.

One of these is an “upside scenario” where house prices pick up pace, returning to a 6% per cent long run growth rate (consistent with average historic UK house price growth).

Nominal income growth, however, remains the same as in the central scenario, driving up the house price to income ratio, while the Bank Rate remains the same

The BoE report says: “In this scenario we also assume that banks loosen their underwriting standards, permitting an increase in mortgages with LTI ratios up to 6, and performing affordability tests using a stressed rate of 5.5% instead of the 6.75%.

“This relaxation of policies is consistent with the broader scenario in which rising house prices, and the resulting stretch to borrower affordability, could reasonably be expected to cause some banks to adjust their affordability criteria in order to avoid a reduction in mortgage approvals or a loss of market share.”

However, the BoE notes that these various scenarios do not include “an additional deterioration in borrower quality above and beyond what is set in the underwriting standards”.

“For example, we do not assume any reduction in income for a fraction of new borrowers, as we do not attempt to capture a pool of borrowers that is currently rejected but may not be if the underwriting standards were to loosen.

“As a result of the substantial increase in house prices, not accompanied by a commensurate rise in income, we would expect the upside scenario to result in a substantial increase in the number of high LTI loans, a pattern seen during previous UK housing cycles.”