The Bank of England has announced plans to relax mortgage lending rules from August 1st. This should make it easier for first-time buyers as currently, borrowers have to show they can afford repayments on their lender's higher variable rate if the interest rates rise by 3%. After consulting lenders and other members of the industry, the Bank's Financial Policy Committee (FPC) has said it will scrap the rule this summer. This comes at a time when rising interest rates and high house prices are already making it challenging for people to get on the property ladder.
The rule was first introduced in 2014 to protect the banking system from high levels of debt following the financial crisis in 2008. The FPC called on lenders to make sure borrowers could still afford their mortgage repayments when their fixed rate deal ended and if interest rates rose.
As a result, lenders had to make sure monthly repayments were still affordable if borrowers were moved on to their standard variable rate and interest rose by 3%.
The FPC also asked lenders to limit the number of mortgages they offered to people borrowing 4.5 times their income to 15% of their total lending.
When the rule was introduced, interest rates were expected to rise to 2.25% in the coming five years. When the FCA first launched its consultation around lifting the rule, it seemed highly unlikely that interest rates would hit this level in the years ahead. As a result, the FCA thought the tet was no longer needed. But since then inflation has soared to a 40 year high of 9%, causing the Bank of England to raise interest rates five consecutive times to 1.25%.
While that is still well down on the 2.25% anticipated when the test was introduced, interest rates are now expected to rise to 3%, or possibly higher, next year.
The average standard variable rate is already just under 5%. If interest rates rise by a further 1.5%, borrowers would have to show they could afford a mortgage rate of 9.5%.
For example, if someone was borrowing £180,000 on a two year fixed rate mortgage with an interest rate of 2.5%, their monthly mortgage repayments would be £815.
But if they would have to prove that they could still afford their mortgage if the interest rate was 9.5% and their repayments were £1,590 a month - almost double the amount they would actually pay.
Such a tough test would exclude many people from taking out a home loan.
While the FCA has not commented on this issue directly, it is thought to be one of the reasons it is withdrawing the rule so quickly after the consultation concluded.
The decision to withdraw the rule is good news for homeowners who have borrowed a relatively high proportion of their salary and would need to remortgage in the next few years.
It is particularly good news for first-time buyers, who typically have lower salaries and smaller deposits, making them more likely to struggle with the test.