FPC withdraws affordability test Recommendation for mortgage lending

The Financial Policy Committee (FPC) has withdrawn its affordability test Recommendation with effect from 1 August 2022, the Bank of England said in a response to consultation published on 20 June 2022¹. The Recommendation, addressed to mortgage lenders, had specified a stress interest rate for lenders to apply when assessing whether prospective borrowers could repay a mortgage¹.

The FPC introduced two Recommendations in 2014 to guard against loosening in mortgage underwriting standards: the loan to income (LTI flow limit), which limits the number of mortgages that can be extended at LTI ratios at or greater than 4.5, and the affordability test¹. The LTI flow limit remains in place¹. The affordability test was revised in June 2017 and required lenders to assess whether borrowers could still afford their mortgages if, at any point over the first five years, their mortgage rate were 3 percentage points higher than the reversion rate specified in the contract at origination¹. Both applied to lenders extending residential mortgage lending in excess of £100 million per annum¹.

The consultation, launched in February 2022, received 27 responses, including from four trade bodies representing the majority of mortgage providers and intermediaries, major and smaller lenders, building societies, third sector organisations and members of the public¹. The majority of responses, including all four trade bodies, supported withdrawal and agreed that the LTI flow limit and the FCA's Mortgage Conduct of Business (MCOB) framework ought to provide the appropriate level of resilience¹. The FPC said the feedback provided no evidence that removing the affordability test would have a significant impact on the mortgage or housing markets¹.

The FPC judged that the LTI flow limit is likely to play a stronger role than the affordability test in guarding against an increase in aggregate household indebtedness when house prices rise rapidly, and that the additional insurance provided by the affordability test is small¹. It noted that the stress rate required by the test had remained broadly static, reflecting stickiness in reversion rates despite past falls in average quoted mortgage rates¹. The FPC chose a six-week notice period, saying a longer one could strengthen incentives for prospective borrowers to delay applying for a mortgage, and that mortgage reversion rates had risen since February with a market expectation of further rises in Bank Rate¹.

Why it matters for households

Affordability will continue to be assessed under the FCA's MCOB rules on responsible lending, which require lenders to assess income and expenditure and, in relevant cases, the effect of future interest rate rises over five years from the expected start of the mortgage¹. In coming to a view on likely future rates, a lender must have regard to market expectations and any prevailing FPC recommendation, and must assume rates rise by a minimum of 100 basis points over the period even if its assessment suggests they will fall or rise by less¹.

The withdrawal does not require lenders to change anything, and it is up to individual lenders whether to adjust their own lending practices and when to do so after 1 August¹. Consultation feedback indicated that two to three months might be needed for lenders to operationalise any changes they choose to make, though any system or process changes were unlikely to be material to implement¹. The FPC confirmed in September 2017 that the affordability test Recommendation did not apply to remortgaging where there is no increase in borrowing, whether with the same or a different lender¹. The LTI flow limit continues to cap lending at high LTI ratios¹.

What happens next

The FPC said it will continue to monitor the level of household debt and the share of highly indebted households, reviews its measures regularly, and retains the power to make a future Recommendation, for example in the event of a significant decline in underwriting standards or an increase in household indebtedness that threatens UK financial stability¹.