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Banks are subjecting borrowers to rigorous affordability checks, but you may be able to make the grade.
Mortgage deals for those with a small deposit have returned from the exile imposed after the credit crisis. Aspiring homeowners may, however, still find it difficult to secure a home with a deposit of less than 15 per cent of the purchase price because mortgage lenders are still applying punitive checks to test borrowers’ ability to repay loans.
Stress testing, as it is known, is not a practice a mortgage lender is keen to shout about, but behind the scenes banks and building societies are assessing your ability to meet mortgage costs about three times higher than current interest rates.
Research by Hometrack, the property data company, shows that 52 per cent of potential first-time buyers renting a two-bedroom home are paying more to their landlord than they would for a mortgage worth 90 per cent of the property’s value. However, only 2 per cent would be able to afford the projected monthly costs of a lender’s stress test. Richard Donnell, the research director at Hometrack, says: “Stressing borrowers’ affordability at such high rates is dampening the first-time buyer market and making it difficult for creditworthy borrowers to buy properties with less than a 15 per cent deposit.”
How does the stress test work?
The Bank of England’s Financial Policy Committee (FPC) wants to prevent homeowners from taking on high levels of debt that they would struggle to repay if interest rates began to rise.
To inhibit the flow of lending, the FPC has insisted that lenders assess applications for mortgage finance based on a 3 per cent rise in interest rates over the first five years of the loan. Banks and building societies have interpreted this rule to mean that borrowers must have enough income to afford a payment 3 per cent higher than the lender’s standard variable rate (SVR). A typical SVR is 4 to 4.4 per cent, which means borrowers must be able to afford a monthly mortgage payment based on a rate of about 7 per cent.
For example, a borrower with a 5 per cent deposit looking to buy a 250,000 home would need a mortgage of 237,500. Based on a typical three-year fixed rate of 2.69 per cent, the monthly mortgage payment would be 1,088. Rather than assessing whether the borrower can afford to repay this, or even the SVR of about 4 per cent, lenders are requiring the borrower be able to pay 7 per cent – 1,679 a month. That extra 591 puts many out of the market.
Are all lenders doing this?
For house purchases, yes, but their exact calculations are kept secret from borrowers and mortgage brokers to minimise attempts to manipulate them.
Stressing borrowers at such high rates is dampening the market
The stressed monthly mortgage payment feeds into a wider income and expenditure assessment that can vary from lender to lender. Simon Collins, of John Charcol, the mortgage broker, says that regional building societies often adopt a more flexible approach by checking applications manually and applying common sense.
Is there anything I can do to help me to pass the stress test?
The obvious solution is to lower the cost of the mortgage by reducing the amount you need to borrow. However, not many buyers are in a position to raise additional funds. Another option could be to shop for the lowest mortgage rates today in your locality to learn about the market, average interest over the return, mortgage time period, etc.
Taking out a mortgage product with an initial term of five years or more may help. Lenders are required only to assess the impact of an interest rate rise during the first five years of the loan. Speak to a mortgage broker to find out which lenders are using lower stress tests for these types of products. If you don’t know of any reputable lenders, check out something like mortgage Red Deer to learn more. It’s really important that you work with a professional and reliable lender so take your time to find the right one.
A guarantor mortgage would not help in this situation. Those available help borrowers only to raise a deposit rather than helping them with monthly affordability. They can also impose stricter stress tests to protect the guarantor’s money. Then there are some buyers who might not be eligible for a home loan of the required amount. This can be due to personal credit issues. In such cases, some people prefer to opt for seller carry-back mortgages (visit here to know more about such provisions) where the owner can finance the house for sale, and the buyer can pay back with regular instalments. This way, the buyer gets to become a homeowner and the seller can get a higher price for the property.
There can be a few other ways to beat the stress test. For instance, as an alternative, the buyer can add someone on to the mortgage but not the title deeds. Mr Collins says: “Applicants struggling to pass the affordability assessment can opt for a joint application/sole proprietor. This differs from a guarantor mortgage because the added person, usually a family member, is liable to pay the full amount of the mortgage cost, whereas a guarantor agrees only to pay any shortfall.
“Lenders such as Woolwich, Metro Bank, Hinckley & Rugby Building Society, and Furness Building Society will accept applications on this basis.”
Mr Collins says that by not being added to the title deeds, family members can avoid capital gains tax liability when the property is sold.
Stretching the mortgage term will allow borrowers to lower monthly payments and is no longer just an option for younger homebuyers. Most lenders have relaxed their criteria around the maximum age of applicants at the end of the term. Economising in preparation for your mortgage application is also recommended.
What the experts say
Mortgage companies are lobbying for the Bank of England to change the 3 per cent stress level, but there are no plans to lower it at the moment. Mark Graves, the sales director at the mortgage distributor Sesame Bankhall Group, says: “Stress testing is not going anywhere – it is sensible to make sure borrowers have enough spare income to comfortably afford a rise in interest rates. What we need to see is more flexibility within the checks that lenders set themselves. We are starting to see this in their approach to those who work on a contractual basis and options for self-employed borrowers continue to improve.”
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