To Stress Test, or not to Stress Test?

What is the affordability test?

If you’ve never heard about this test, you’re not alone, but it’s certainly affected you or other first-time buyers that have attempted to take their first step on the property ladder.

It is a test applied by mortgage lenders to borrowers to ensure that they can meet the required mortgage repayments over the loan’s term. More specifically, it tests whether a borrower can continue to make payments at the standard variable rate, plus 3%. In the current interest rate environment, this roughly equates to testing if homebuyers can pay a 7% interest rate: a far higher interest rate than what is charged on most fixed rate deals currently available in the market.

Why was the affordability test instituted?

Affordability became an important topic during the financial crisis when many borrowers could not remortgage onto a new fixed rate deal and consequently reverted to their standard variable rate. This left those effected paying much more than during the fixed term, squeezing their household finances.

Following the financial crisis, there was a renewed call from regulators to improve the resiliency of the financial system. One of the ways they chose to do that was to ensure that mortgage borrowers are only taking out loans that they can afford to repay monthly, even if they reverted from their low fixed rate to the standard variable rate.

To increase the odds that mortgage borrowers could make their monthly payments over the life of the loan, the Prudential Regulatory Authority instituted the affordability test, requiring mortgage lenders to “stress test” customers at higher rates.

How does the stress test affect first-time homebuyers?

Elevated housing prices, which lead to large deposit requirements, are most widely known reason why first-time buyers have a hard time affording their first home. However, restrictive lending criteria instituted by the Bank of England is certainly another major factor that contributes to the first-time buyer problem.

By stress testing first time homebuyers at such a high interest rate, it acts to limit the size of the mortgage they can take out. This will limit the choices a first-time buyer has when purchasing a home, or even prevent them from taking that first step on the ladder entirely. The Bank of England has tracked the effect of the rule change and shows that 6% of borrowers, or 30,000 a year, have had to take out a smaller loan than they otherwise could have.

What do first-time buyers need to know?

Late last year, the Bank of England proposed to withdraw the affordability rule entirely, and earlier this week, the Financial Policy Committee issued a consultation to solicit feedback from the mortgage industry. While it’s not official yet, it is more likely than not this rule will be scrapped all together.

Our Non-Executive Director Jackie Bennett weighs in, “It's good that the PRA is consulting on whether the stress test should remain.  It is right that lending should be responsible, and affordable for the borrower, but there are other rules in place to ensure this happens.  The stress test has been a bit of a blunt instrument in a low interest rate environment.'

While real solutions for first time buyers are still needed, this is welcome news for those effected by the rule and could make the difference between getting your first home, or not.

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OnLadder is the trading name of OnLadder Loans Ltd, a company registered in England and Wales under registration number 13642073. Our registered office is Kemp House, 160 City Road, London EC1V 2NX. OnLadder Loans Ltd. is a subsidiary of OnLadder Ltd., registered in England and Wales under registration number 12677436. OnLadder Ltd's registered office address is 71-75 Shelton Street, London, England, WC2H 9JQ.

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