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Bank of England sets out new limits on amounts banks can lend on risky mortgages

Large UK banks should limit the amount of mortgages they approve where the loan is more than 4.5 times the value of the customers’ annual income to no more than 15% of new residential mortgage approvals, the Bank of England has said.

The Financial Policy Committee (FPC), which oversees UK financial stability, has asked financial services regulators the Prudential Regulation Authority (PRA) and Financial Conduct Authority (FCA) to implement the change as soon as possible. The new limits will apply to all firms that lend more than £100 million per year towards residential mortgages, meaning that in practice they will predominately affect PRA-authorised firms.

Following its June meeting and publication of its half-yearly financial stability report, the FPC has also recommended the introduction of a new affordability test for mortgage customers. This will test whether borrowers would still be able to afford their repayments if interest rates were to rise by 3%.

However, Bank of England governor Mark Carney said that the FPC did not believe “that household indebtedness poses an imminent threat to stability”.

“History shows that the British people do everything they can to pay their mortgages,” he said. “That means cutting back deeply on expenditures when the unexpected happens, potentially slowing the economy sharply. That’s why recessions that follow periods of rapid credit growth, like the record one from which the UK is emerging, tend to be deeper and longer lasting. It is prudent to insure against these risks.”

“These actions should not restrain current housing market activity. The recommendation on affordability tests is in line with the current practice of prudent lenders. And the current share of new mortgage lending with LTI [loan to income ratio] in excess of 4.5 is around 10%,” he said.

UK house prices rose by a further 10% on average in the year to March 2014, returning them to the levels that they reached in late 2006. Although this growth has been most pronounced in London, house prices rose by more than 5% in 10 out of 12 UK regions across the same period.

Responding to the announcements, the Council of Mortgage Lenders (CML) said that the new cap was likely to impact the London market “more than elsewhere”. “Nationally, 9% of new loans are at 4.5 times income or more, but the figure is 19% in London,” said Paul Smee, director general of the body that represents the lenders that together provide around 95% of all UK residential mortgages.

The PRA has published its proposals for implementing the new rules for consultation, and intends to apply them from 1 October 2014. It has said that mortgages granted in principle before this date, but which will not complete until after 1 October, will also be subject to the limits. However, it said that it did not expect firms to have to change their lending practices as a result of the change in policy.

“Lenders should continue to apply whatever criteria they feel are appropriate and commensurate with their risk appetite when taking individual lending decisions,” it said in a statement.

The FCA, which is responsible for the prudential regulation of those firms that are not authorised by the PRA as well as for conduct and compliance, said that the FPC’s recommendations were “consistent” with its own aims. The Mortgage Market Review, introduced by the FCA in April, prevents firms from lending to borrowers without the means to repay loans particularly if interest rates were to rise.

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