FPC withdraws mortgage affordability test

The Bank of England's Financial Policy Committee (FPC) has withdrawn its mortgage affordability test, the committee's external member Colette Bowe said in a speech published on 7 September 2022¹. The test required lenders to assess whether borrowers could still afford their mortgages if interest rates rose by 3 percentage points¹. The withdrawal followed a consultation on the Bank's housing tools, which Bowe said "ought to be called mortgage market tools"¹.

The affordability test sat alongside rules introduced by the Financial Conduct Authority (FCA) after its Mortgage Market Review. In 2014 the FCA introduced tougher requirements for lenders to ensure prospective borrowers could afford their mortgages, including verifying income and taking account of other debt and spending commitments, and testing whether borrowers could still afford a loan if rates rose during the first five years where the rate is variable or fixed for less than five years¹. The FPC supplemented those rules with the 3 percentage point test and a separate requirement, the flow limit, which caps loans of more than 4.5 times income at 15% of a lender's new lending¹. The flow limit remains in place, and Bowe said "the underlying FCA framework remains in place"¹.

Bowe also set out the FPC's wider monitoring of household debt. The total stock of UK household debt excluding student loans was just under £2 trillion in the first quarter of 2022, equivalent to around 124.5% of total household income, below the 2008 peak of 146%¹.

On affordability pressures, Bowe said households with mortgage debt service ratios at or above 40% were more likely to experience repayment difficulties during the financial crisis; in the first half of 2022 the share of such households rose to around 1 ¾%, broadly in line with pre-crisis averages¹. Using a new cost of living adjusted measure introduced in the July Financial Stability Report, the share of households with high debt service ratios is likely to remain at around 1.7% over the course of 2022, below the pre-2008 level of 2.8%¹. Bowe said the equivalent threshold at which households are likely to struggle with repayments is 70% of disposable income¹.

Why it matters for households

The withdrawal removes one of the checks lenders applied when deciding how much to lend. Borrowers applying for a mortgage will still face the FCA's affordability rules, including income verification and checks on other debts and spending, and lenders must still keep loans above 4.5 times income within 15% of new lending¹. The change does not alter the terms of mortgages already taken out.

The speech points to pressure on household budgets from rising living costs and interest rates. Bowe said the rise in living costs and interest rates will put increased pressure on the finances of UK households in the coming months, with lower-income households in particular finding it difficult to adjust their spending¹. She noted that most households are on fixed rate mortgage contracts and will not necessarily see payments change in the very short term, but that fixed rate deals available in the market are changing rapidly, so many borrowers will face higher payments when they come to re-mortgage¹. The August Monetary Policy Report, she said, showed the outlook is even more challenging for UK households than at the time of the July Financial Stability Report¹.

What happens next

The 2022 annual cyclical scenario stress test will be launched later in September 2022, assessing the resilience of the UK banking system to deep simultaneous recessions in the UK and global economies, real income shocks, large falls in asset prices and higher global interest rates¹. The FPC will continue to monitor UK household debt vulnerabilities¹.