The past few years have seen borrowing become more affordable. Interest rates have dropped, mortgage rates have fallen and many a homeowner made the smart decision to lock in a low rate for a fixed term and drop their monthly payments significantly.
Just this April, the Yorkshire Building Society announced its lowest ever introductory offer of just 0.89% on a 65% LTV mortgage with a Standard Variable Rate of 4.74%, down from 4.99% as they confirmed they’d be passing on the 0.25% Bank Base Rate cut to its customers.
The new mortgage affordability testing changes coming into effect aren’t going to alter your repayments immediately, but they may very well make it more difficult to be approved for a mortgage or remortgage.
New Affordability Testing for Mortgages
All lenders will need to assess your affordability at 3% above the offered Standard Variable Rate. In the case of the example used above with Yorkshire Building Society, you would need to prove you could afford the repayments based on a 4.74% interest rate, rather than the discounted rate offered of 0.89%.
A hypothetical working example of the changes in action…
- Property price: £100,000
- Mortgage: £65,000
- Term: 25 years
- Interest rate of 4.74%
- Monthly repayments of £370.20
Adding the 3% for affordability testing, you’d need to afford £490.54 a month
If it were calculated at the discounted rate, you’d be looking at figures of £241.74 with the 3% additional cushion for interest rate rises would mean you’d need to afford £339.16 a month. Because it’s the advertised SVR though, you need to afford the highest amount possible and in the example above, that’s a monthly difference of £151.38.
In June of 2017, MoneyFacts.co.uk reported that the average SVR stood at 4.59%. Under the new regulations imposed by the Bank of England, that translates to borrowers being required to afford to repay the mortgage based on an interest rate average of 7.59%.
The lowest 10 SVRs as reported by The Telegraph stands currently as:
- First Direct 3.69%
- Barclays 3.71%
- HSBC 3.73%
- Investec 3.75%
- Nationwide 3.75%
- TSB 3.79%
- Halifax 3.79%
- Lloyds 3.82%
- Metro Bank 3.82%
- Scottish Widows 3.83%
- Royal Bank of Scotland 3.83%
Those rates are for mainstream lenders. With bad credit, you need to be comparing the rates from subprime lenders.
A quick comparison on Money.co.uk showed Precise Mortgages offering a 75% LTV loan with an initial rate of 3.84% on a 3-year fixed term deal then reverting to a Standard Variable Rate of 5%. For affordability testing under the new guidelines, you’d need to be able to prove you could afford the repayments at a rate of 8%. Costs wise, that’s £379.98 per month but assessed as £501.68, £121.70 higher per month. Or on an annual basis that’s just shy of £1,500.
The subprime sector usually has higher interest rates so that can push your repayments up further, depending on the level of risk posed to lenders.
How many homeowners are likely to be affected?
It will be very few in the near future. The Council of Mortgage lenders report that the vast majority of mortgages are currently sitting on fixed rate mortgages. 80% of all new regulated lending is on fixed rate too, so an immediate interest rate increase will not take an instant impact on household finances. It will when the fixed year deal ends though.
4.2 million Mortgages will reach the end of their term either this year or next though so if (or when) there is a rate increase by the Bank of England, there will be a rise in mortgage costs. They also state that the majority of existing mortgages have enough equity in the property to remortgage at the Loan to Value required, whether that be 60% LTV, 75% LTV or as high as 90% LTV.
The important thing for those with fixed rate deals due to expire is to start shopping around.
It’s worth pointing out that you don’t need to wait until your fixed term deal is nearly up. You can remortgage as long as seven months prior to your current term ending and take advantage of the currently low interest rates. You will still need to pass the stricter affordability requirements though.
Whatever rate you see as the advertised interest rate isn’t what you’ll need to prove you can afford. It’s 3% higher than the lenders Standard Variable Rate, sometimes referred to as the Reversion Rate. So, when you are comparison shopping to switch your mortgage, the discounted rate is only part of what’s assessed. You’ll need to look at the lenders current SVR and then add 3% on to that to determine if you will be able to pass the new affordability test.
To make it easier for you to assess the cost of a mortgage, the Money Advice Service have updated their Mortgage Calculator to show you both what you will pay and what you’ll need to be able to afford by giving both figures – the cost to you and the potential cost with the additional 3% added. Just remember to input the Standard Variable Rate for the offer you’re considering applying for because it’s not based on the introductory rate, which is often lower.
Mortgage Experts Split on How the Change Will Affect Consumers…
Speaking to The Telegraph, “Ian Gordon, a banking analyst at Investec, the specialist bank, said some “at the margins” might see their affordability shrink.”
David Hollingworth, a director at London & Country (mortgage brokers) comments: “Larger lenders won’t be seeing this as a radical change,” he said. “It will mean they won’t be able to consider loosening their stress test if they think competition is edging ahead. That’s what this report is all about.”
The past few years have seen interest rates drop to record lows. Lenders are increasingly being competitive to win more customers, which is raising concerns with regulators as to how much they’re willing to play loose with their stress testing for affordability. As a result, the Bank of England has introduced these rules to avoid the competition getting out of hand and reaching a stage of irresponsible lending by playing too loose with affordability testing and setting a minimum 3% above each lenders Standard Variable Rate, ensuring that in the event of an interest rate rise, consumers won’t be stung so bad that they’re pushed into the unaffordable bracket and forced to sell their home, downsize or struggle to keep up repayments. In that respect, it is a good and safe move. The bad news is that interest rates will rise in the future, and it is likely to have some lower income households struggle to obtain a mortgage.
What You Can Do to Plan for Future Mortgage Offers…
The importance of looking after your credit files is now more important than ever. The lowest SVR is currently offered with First Direct at 3.69%. Buying a property priced at £125,000 with a £25,000 deposit over 25-years would require an 80% LTV mortgage. At 3.69%, you would need to afford repayments of £687.13 per month. With adverse credit, that could push you towards a 5% SVR with a subprime lender, resulting in affordability being assessed as you needing to prove you could afford £771.82 per month repayments. An increase of £84.69 per month and it may only be something minor that pushes you into the riskier category, when in reality, you could be considered as a Near Prime borrower, rather than requiring a subprime mortgage.
Will the Changes Affect Your Ability to Remortgage?
With the more stringent affordability criteria to obtain a mortgage, it’s important that you get your application put in front of the best lender most likely to approve your mortgage. As a mortgage is a secured home loan, you must be risk assessed, which requires a hard check on your credit file. Each check lowers your credit score and makes it more difficult to get approved by the next lender you apply to.
1st UK Mortgages work with a diverse panel of lenders some of whom are available direct, with others offering more flexible borrowing with favourable rates (as low as 1.19%) being available as broker only deals. To get in contact with one of our experienced mortgage advisers, use our contact form here, or call us on: 0203 129 3081.