The Bank of England (BoE) has recently announced an update to its affordability rule introduced in 2014. This change will mean that a huge swathe of new borrowers and existing borrowers looking to remortgage may be priced out of the market.
How it works now, and what will change
Currently, when lenders are assessing affordability, they will use an income multiple to determine the maximum borrowing level. They would then also stress test this monthly mortgage payment against an affordability rate, which, up until a few weeks ago, was based on a stressed rate of 3% above the BoE base rate.
Now the lenders will need to stress your monthly mortgage payment against a stressed rate of 3% above their Standard Variable Rate (SVR).
Hang on, what’s a Standard Variable Rate?
SVRs are the internal interest rate of a mortgage lender and it is the rate you will switch onto once your initial product expires. These rates can vary widely in the market, with some sitting at 3% at present, going all the way up to 9% when using the more specialist smaller lenders. Ideally, you do not want to be on this rate and would look to switch products or lenders when your initial product expires.
The SVR is important, and although you may not end up spending any time on this rate, it is the rate that will be used by the lender when assessing your affordability. That is why it is potentially problematic for some borrowers that the lender will use their SVR plus 3%, rather than the BoE’s base rate plus 3%.
How this will affect the mortgage market in the UK
The Bank of England estimates that, had these measures been in place when mortgages were tested at the end of 2016, it would have reduced the mortgage approvals by only 0.5%. It does put into question then, with such a low impact, why this change has been issued in the first place.
Despite what the central bank says, these changes will have a direct effect on borrowers. With SVRs currently averaging 4.56%, it means that your mortgage will now be assessed based on a monthly interest rate of over 7%. This will have big implications for a number of borrowers and their proposed loan amounts moving forward.
A practical example
Take an average couple, Tom and Jane who have two children in nursery school. They approach two lenders that offer income multiples at 4.5 x income or above. Tom and Jane earn £100,000 combined, with low credit card debt and a car loan of £200 per month. Currently, their biggest expense is nursery fees, which total £1,800 per month. They have a sizeable cash deposit and are able to look at a loan to the value of 75% of the property they plan to buy. All this will give them access to better income multiples and rate options at most banks.
The property they are looking at is £400,000 and they want to borrow £300,000 which, if you look at the income multiple above, should be affordable. However, when we approach two lenders, under the new rules for borrowing, we get the following maximum figures:
Lender 1: £200,000 maximum borrowing
Lender 2: £483,900 maximum borrowing
That is over double available to Tom and Jane from Lender 2, which is down to how differently both lenders assess affordability.
Why the massive difference?
With lender SVRs and their affordability models varying so much in the market, it is now more important than ever to consider using a mortgage broker when assessing your mortgage options. Without thorough and often painstaking research into all your lender options, you can land up getting a mortgage deal that is sub-optimal.
You need to find a mortgage broker who has an aerial view of the whole of market and is able to assess your affordability against all the available lenders. Only in this way can you ensure that you get the maximum amount available at the most competitive interest rate. Don’t forget that approaching too many banks by yourself can also run the risk of multiple credit scores. This alone can impact not only the lenders available, but what income multiples you can achieve too.
If you have any questions about SVRs, taking out a mortgage or remortgaging your current loan, speak to one of our expert advisers by emailing email@example.com or giving us a ring on +44 (0) 20 7759 7519.
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