Property buyers could soon borrow thousands more – and buy far bigger homes – thanks to a small, technical rule change.
The Bank of England is relaxing lending by scrapping a punitive mortgage affordability stress test from August, which will enable buyers to take out larger mortgages despite interest rate rises.
This could allow buyers to borrow 16pc more, adding £27,500 to a typical first-time buyer budget, according to analysis firm Capital Economics.
So should aspiring homeowners wait to take advantage of the rule change to borrow more? Or will it make little difference as inflation bites into finances?
Buyers could find they can afford to purchase bigger houses
The changes mean that lenders will no longer have to check that borrowers can afford to pay its standard variable rate if it climbs by three percentage points. Instead, they will only have to stress test borrowers against SVR plus one percentage point, according to rules set by the Financial Conduct Authority.
A buyer applying for a £220,000 mortgage over five years needs to be able to afford monthly mortgage payments of £1,662 per month, according to calculations by fund shop Hargreaves Lansdown. This is because current SVR rates are around 4.75pc, meaning the existing stress test would require a borrower to be able to afford payments at 7.75pc.
This means that a buyer would need to have monthly take-home pay of £2,862 to qualify. For a joint-income household, this would mean an annual income of £40,000.
If lenders opt to lower their stress tests to SVR plus one percentage point, a borrower would only be tested against a mortgage rate of 5.75pc. This means they would only need to be able to afford monthly payments of £1,384 to take out the same mortgage – £278 less per month.
But there are several other moving parts to the equation. Soaring inflation means that if a buyer decides to wait, they could also find their borrowing power reduced because the bank will have increased its calculations of their outgoings.
The Bank of England is also expected to make further rate rises, which will further push up mortgage costs, and the level buyers are stress tested against.
And lenders may not decide to cut their stress tests all the way down to the FCA minimum benchmark.
Lucian Cook, of Savills estate agents, said: “I think a number of buyers will wait before they buy now, given that they will only have to wait until August and the stress test is a strenuous hurdle.”
So should you wait or buy now? We have broken down the numbers for three different scenarios.
Inflation bites – and take-home pay falls
Currently, lenders use official data that is on a lag, so does not yet take into account the very high rate of inflation. If a mortgage provider adjusts its calculations based on 9pc inflation, the buyer’s monthly outgoings in its mortgage calculations would rise from £1,200 to £1,308.
This means that a couple with monthly take-home pay of £2,862 would be able to afford monthly mortgage payments of £1,554.
This would be £170 more than the £1,384 per month that a lender would require, if it had dropped its stress test to 5.75pc, or SVR plus one percentage point based on current interest rates.
The surplus is money that the buyer could use to take out a larger mortgage. Sarah Coles, of Hargreaves Lansdown, said: "It would mean that you would be better off waiting."
The Bank Rate keeps rising
The Bank of England will make another interest rate decision on 4 August. It is likely that it will decide to raise the Bank Rate by a further 0.25 percentage points to 1.5pc. Further rate rises are in the pipeline.
Pantheon Macroeconomics, a research firm, expects the Bank Rate will peak at 1.75pc after a second rise in September. Capital Economics, another analyst, expects rates to rise far higher to 3pc in 2023.
Even if interest rates only in line with the lower forecasts, the goalposts for borrowers would move again.
If lenders stress test at SVR plus one percentage point and the Bank Rate is 1.75pc, a borrower will need to afford mortgage repayments at 6.25pc.
This means they need to be able to cover monthly bills at £1,486. Assuming their outgoings are adjusted for 9pc inflation, their take-home pay would still be £68 above the bank’s minimum monthly benchmark.
This means they would only just be better off waiting for the stress test to be scrapped. If the Bank Rate rose further, they would soon find that they could no longer meet the affordability requirements.
There could only be a very small window this summer just after the stress test is scrapped and before the Bank Rate rises further when buyers can get a bigger mortgage.
A higher stress test and rising rates
But it is not guaranteed that every lender will decide to scrap the stress test altogether. It is feasible that some could choose to keep the higher stress test.
If lenders choose to stress test at SVR plus two percentage points, for example, it would not make sense for buyers to wait.
Assuming the Bank Rate rose to 1.75pc, a buyer would need to be able to afford to make payments at 7.25pc, or £1,625 per month.
This would still be lower than the existing stress test at 7.75pc, but because they had waited, the buyer would also see their affordability shrink because of the impact of inflation on their outgoings.
If the bank’s calculation of their outgoings climbed to £1,308 in line with 9pc inflation (and the Bank of England expects this to rise further to 11pc by October), a household with take-home pay of £2,862 would only have £1,554 to cover their mortgage. This means they would fall £71 per month short of the stress test. Ms Coles said: "It would mean that by waiting you’ve priced yourself out of a mortgage."
Will house prices rise further?
Another risk with waiting is that house prices will rise further. The EY Item Club, a forecaster, expects 8pc house price growth this year.
The decision to scrap the affordability test in itself could inflate growth further because it will increase access to lending. Mr Cook said: “It will help the market mitigate against interest rate rises.”
But these effects will likely be more medium-term, perhaps from 2024, said Mr Cook.
In the short-term, he still expects the market will continue to slow down as the cost of living crisis bites. “I think the market this year and next will be more about sentiment than anything else.”