The Bank of England has tightened mortgage affordability rules to prevent loosening underwriting standards, which it warns will cause some lenders to raise interest cover ratios.
The Bank formerly said that lenders should test affordability by checking how borrowers would react to a three per cent increase in base rate.
But the new rule says lenders should instead consider how borrowers would handle a 3 per cent increase in firms’ standard variable rates.
The Bank says lenders have been using different approaches and coming up with different stressed interest rates to test affordability, leading to “lack of consistency across the market”.
The old rule let some lenders choose between whether correct rate was the one at the point the mortgage was sold or the rate it reverted to.
The Bank’s latest Financial Stability Report says: “Indeed, there has been significant variation across lenders on the stressed mortgage rate used to assess affordability compared to their current SVRs.”
This difference in lender approach means that around 0.5 per cent of all 2016 mortgage approvals would not have met the requirements of the new rules.
The Bank says some lenders will have to increase their ICRs as a result of the new rule, though it expects the overall impact on mortgage lending to be small.
The report says half the mortgages sold in the last quarter of 2016 were tested using a rate of lenders’ SVR plus 2.75-3.25 percentage points.
Around 30 per cent of mortgages were tested at a lower rate, and about 20 per cent at a higher rate.
The report adds: “Lending conditions in the mortgage market are becoming easier and competitive pressures in the market remain.
“So there is a risk that lenders loosen the standard at which they test affordability, especially if there is significant scope for interpretation of the policy.
“The new recommendation promotes consistency of implementation across lenders and insures against the risk of loosening underwriting standards.”