At the end of this month, the Bank of England will drop the affordability test that banks have been forced to run on potential mortgage customers, a move in line with the Conservative government’s drive to scrap regulation.” useless “.
Unwarranted bureaucracy can, of course, hamper efficient markets and access to finance. But it’s hard to imagine a more bizarre time to kill the BoE’s affordability test, which over the past eight years has seen homebuyers face a 3 percentage point hike in rates. of interest.
Households are being strained by soaring energy prices and inflation is expected to reach 11% by the end of the year. Recession is almost inevitable, with unemployment levels – a key determinant of mortgage default rates – set to rise from 3.8% now to 5.5% within three years.
Simultaneously, interest rates – ultra low for more than a decade – started to rise rapidly: the BoE base rate is now at 1.25% after a series of 0.25 point hikes. Governor Andrew Bailey hinted that a 0.5 point hike is possible soon. Respected former member of the Monetary Policy Committee, Adam Posen, predicted that rates will have to rise to 4% to hopefully contain inflation.
In this context, it would make sense for a regulator that did not have a mortgage affordability test in its arsenal to come up with one. Eliminating an existing test is simply obtuse.
The BoE’s own research showed that around 6% of borrowers, or about 30,000 people a year, took out smaller mortgages than they would have if the affordability test had not existed. These 30,000 people could now borrow more.
The BoE’s rationale is that the test is superfluous. There are other measures in place, such as limits to prevent banks from issuing too many mortgages at high earnings multiples. And the BoE’s sister regulator, the Financial Conduct Authority, applies a stress test to determine whether borrowers could face a 1 percentage point rate hike.
The regulator and the mortgage industry say the system should work well, even in the difficult years ahead. They point to crucial differences between now and the period of the 2008 financial crisis, when house prices fell 15% and the mortgage industry seized up as funding markets froze. Banks now have larger capital cushions and less reliance on volatile wholesale funding markets to fund loans. Various regulatory measures have also prevented a hot market from boiling over.
But it is proud to count on the resilience of the market.
House price inflation over the past 20 years has been extreme. Keynesians find it hard to accept that one of the main drivers of this was the explosive impact on asset prices of an ultra-loose monetary policy.
UK property prices relative to wages have become lopsided from all historical trends. The average house price of £280,000 for England and Wales (compared to £175,000 just before the 2008 crisis) is almost nine times the average income (compared to decades of multiples of three to five times until the early 2000s), according to the Office for National Statistics. The £515,000 price tag in London represents 13 times average earnings (compared to a historic range of three to six times). “I think house prices could easily drop 30% over the next few years,” a bank boss told me last week.
Ultra-low rates have helped keep the mortgage market fluid and house prices rising, but lenders have also had to extend mortgage terms (the average is now 28 years, down from 24 a decade ago) to help borrowers add up. Outgoing Prime Minister Boris Johnson recently pushed the idea of 50-year mortgages.
In 2008, one of the most overheated parts of the mortgage market was interest-only lending, where borrowers service their debt but leave the principal as a balloon for the end of the loan term. These risky offers have fortunately lost popularity.
Today, however, there are still 1 million mortgage borrowers on interest-only deals, in whole or in part, according to industry association UK Finance. And in a rising interest rate environment, they can quickly turn toxic.
A pay-off mortgage borrower, moving from a 1% deal to a 4% interest rate, could see a payment of £1,000 a month increase by a few hundred pounds. However, an interest-only borrower with the same upfront outlay might find the monthly payment rocket to £4,000. Suddenly, 11% inflation seems modest.