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At the end of this month, the Bank of England will ditch the affordability test that banks have been obliged to run on prospective mortgage customers. Despite friction with government over the extent of deregulatory initiatives, this move at least is in tune with the Conservatives’ keenness to do away with “unnecessary” regulation.
Unwarranted red tape can, of course, get in the way of efficient markets and access to funding. But it is hard to imagine a more bizarre time to kill off the BoE’s affordability test, which for the past eight years has ensured that home buyers could cope with a 3 percentage point rise in interest rates.
Households are being stretched by rampant energy prices, and inflation in the round is predicted to hit 11 per cent by the end of the year. Recession is all but inevitable, with unemployment levels — a key determinant of mortgage default rates — set to jump from 3.8 per cent now to 5.5 per cent within three years.
Simultaneously, interest rates — ultra-low for more than a decade — have begun to rise fast: the BoE base rate is now at 1.25 per cent after a string of 0.25 point rises. Governor Andrew Bailey has hinted that a 0.5 point rise is possible soon. Respected former Monetary Policy Committee member Adam Posen has predicted rates will need to rise to 4 per cent to have any hope of containing inflation.
Against that background, it would be logical for a regulator that didn’t have a mortgage affordability test in its armoury to come up with one. To eliminate an existing test is just obtuse.
The BoE’s own research showed that about 6 per cent of borrowers, or about 30,000 people a year, took out smaller mortgages than they could have if the affordability test had not existed. Those 30,000 may now be able to borrow more.
The BoE’s justification is that the test is superfluous. There are other measures in place, such as limits to stop banks writing too many mortgages at high multiples of earnings. And the BoE’s sister regulator, the Financial Conduct Authority, applies a stress test on whether borrowers could cope with a 1 percentage point rate rise.
Both the regulator and the mortgage industry say the system should be fine, even through the tough years ahead. They point to crucial differences between now and the period of the 2008 financial crisis, when house prices fell 15 per cent and the mortgage sector seized up as funding markets froze. Banks have bigger capital cushions now, and they rely less on volatile wholesale funding markets to finance lending. Various regulatory measures have also stopped a hot market from boiling over.
But it is hubristic to count on market resilience.
House price inflation over the past 20 years has been extreme. Keynesians find it hard to accept that a key driver of this has been the explosive impact on asset prices of ultra-loose monetary policy.
UK house prices relative to wages have become unhinged from all historical patterns. The £280,000 average house price for England and Wales (compared with £175,000 just ahead of the 2008 crisis) is nearly nine times average earnings (against decades of three- to five-times multiples up to the early 2000s), according to the Office for National Statistics. London’s £515,000 price tag is 13 times average earnings (compared with a historic range of three- to six-times). “I think house prices could easily fall 30 per cent over the next few years,” one bank boss told me last week.
Ultra-low rates have helped keep the mortgage market flowing, and house prices rising, but lenders have also had to extend mortgage tenures (the average is now 28 years, compared with 24 a decade ago) to help the numbers add up for borrowers. Outgoing prime minister Boris Johnson recently pushed the idea of 50-year mortgages.
Back in 2008, one of the most overheated parts of the mortgage market was the interest-only loan, where borrowers service their debt but leave the capital as a balloon for the end of the loan period. These risky deals have happily declined in popularity.
Today, though, there are still 1mn mortgage borrowers on deals that are wholly, or partially, interest-only, according to industry association UK Finance. And in a rising interest-rate environment they can quickly turn toxic.
A repayment mortgage borrower, moving from a 1 per cent deal to a 4 per cent interest rate, might see a £1,000 a month payment rise by a few hundred pounds. However, an interest-only borrower with the same starting outlay could find the monthly payment rocket to £4,000. Suddenly 11 per cent inflation sounds modest.
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