The macroeconomic climate is currently being stressed by supply chain challenges and interest rate hikes. As such, mortgage borrowing has become almost impossible due to the slowing of construction and rising house prices due to scarcity. In addition, it will make it harder for middle class families to afford housing at preferred rates and they will require larger deposits upfront when purchasing new property.
Traditionally the Bank of England (BoE) has always used mortgage borrowing rules as a best practice to ensure both the lender and home buyer can complete their contractual obligations. However, as the velocity of debt creation slows with a slowing GDP from interest hikes, the BoE is easing its rules on borrowing.
Although dangerous, particularly to the home buyer, the idea of scrapping the Mortgage Affordability Test enables borrowing to continue. The test is a 'stress test' that calculates if a borrower will be able to deal with a 3% interest rate increase. Removal of the test helps private borrowers, the self-employed, and freelance workers secure a loan when they need one.
The removal of the Mortgage Affordability test was initially agreed upon in June but came into force on Monday. Mark Harris, Chief Executive of Mortgage Broker SPF, Private Clients, said when questioned that "scrapping the affordability test is not as reckless as it may sound." However, he also went on to say, "the loan-to-income framework remains, so there will still be some restrictions in place; it is not turning into a free-for-all on the lending front.” Mr Harris also noted that “lenders will also still use some form of testing but to their own choosing [and] according to their risk appetite.”
In the short term, however, it's uncertain whether this self-governance and lack of regulatory requirement will work to increase debt creation and thus GDP or not. It's also unsure what will happen if the borrower cannot repay due to interest rates imposed over the term of the loan being above 3%. For instance, in the US, during a similar inflationary period, interest rates were raised practically overnight to double digits to stem inflationary pressure. While the interest rise worked, the depressionary period was bleak.
History Gives a Clue
With existing government currency systems, Japan showed the world in the 90s the introduction of quantitative easing (QE) of their currency, when they raised interest rates. They then had to print more money to offset the reduction in velocity. The result was a type of deflation that also caused a devaluation in the Japanese Yen significantly and continued QE. Will the BoE's move help arrest mortgage challenges, or will it place borrowers in unrealistic repayment scenarios? Will the BoE need to eventually start QE again to ease the arrest of the currency?
In the past four years, money printing has devalued the Great British Pound to 20% of its previous value. This makes borrowers exceptionally uneasy, especially if they can only get a variable rate mortgage. That said, some see the devaluation of our local currency as a prompt to buy a property and hope it appreciates in value over time, acting as a store of wealth. Unfortunately, if buyers enter the market using, in many cases, a £100,000 deposit or comparable to 5% to 10% of the value and are wiped out, they'll likely get priced out of a second chance to buy a home in future.
In the end, the BoE's move seems to somewhat improve short-term money velocity and debt creation, which drives a proportion of the UK's GDP. However, if money printing is required to stimulate GDP growth, base inflation may create even larger interest rates to reduce inflation. Alternatively, the BoE may decide to lower interest rates to achieve the same type of currency velocity.
The BoE's Financial Policy Committee determined, "the Loan to Income (LTI) flow limit is likely to play a stronger role than the affordability test in guarding against an increase in aggregate household indebtedness and the number of highly indebted households in a scenario of rapidly rising house prices."
In addition, Gemma Harle, MD at Quilter Financial Planning, stated, "The change in the affordability rules may not be as significant as it sounds as the loan-to-income 'flow limit' will not be withdrawn, which has a much greater impact on people's ability to borrow."
As mentioned by Mr. Harris, it's unlikely that lenders will not conduct some form of due diligence and ensure some conservation is possible. In addition, the FCA's Mortgage Conduct of Business, the body responsible for lending rules, also requires a broad assessment of affordability.
Conveyancing is the process where legal requirements to buy or sell a property are carried out by the buyer and seller's conveyancing solicitor. Searches on the property are carried out to check for specific risks, which are communicated to both parties, including the mortgage company. A good conveyancer is important to ensure both speed and efficiency in securing a mortgage and purchasing or selling a property.
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The information contained in this article does not constitute financial advice or recommendation and should not be considered as such. Arrow conveyancing does not offer financial advice and is not regulated by the Financial Conduct Authority (FCA), the authors of this article are not financial advisors and are therefore not authorised to offer financial advice.