UK Mortgage Reforms to Support Home Ownership, Limited Risk for Lenders
UK mortgage reforms will support homeownership with limited risk for lenders, as the Financial Conduct Authority (FCA) implemented measures to simplify affordability assessments for borrowers seeking to shorten their mortgage term or refinance with a new lender, Moody’s said.
In a commentary note, the global ratings agency explained that the new rules give lenders more underwriting discretion and increase flexibility for borrowers, while potentially reducing their borrowing costs.
It said the revisions remove the outdated regulatory guidance and align with the principles of Consumer Duty, making it easier for borrowers to discuss options with their mortgage provider and get advice when they need it.
“The new rules now permit lenders to use the Modified Affordability Assessment (MAA) instead of a previously mandated full affordability check when borrowers remortgage or reduce their mortgage terms.
Wider adoption of the MAA could increase competition among banks and potentially reduce their margins. This in turn would reduce borrowers’ costs and modestly lower defaults, especially as fixed-rate periods end and interest rates reset.
Still, several factors may limit its effect. Only about 20% of remortgagers currently switch lenders and undergo full affordability checks.
Lending to borrowers whose financial situations have worsened since their original mortgage or during periods of rising interest rates without full affordability checks may increase lenders’ credit risk.
However, lender discretion, credit reference checks and regulatory oversight requiring lenders to disclose the type of affordability assessments used should mitigate this risk. For borrowers who want to reduce their mortgage terms, the use of MAA would make it easier.
Borrowers’ enhanced ability to qualify for shorter-term mortgages can mitigate the risk of default later in life because of unforeseen lifestyle changes, which is particularly relevant given the current trend toward longer mortgage durations extending beyond retirement age.
According to the FCA, in 2024, 68% of first-time buyers took out mortgages with terms of 30 years or longer. At the same time, we expect the number of borrowers wanting to reduce their mortgage terms to remain low in the current environment of high interest rates, low affordability, economic uncertainty and elevated living costs.
In addition, most mortgages already allow partial prepayments without penalties, and interest only borrowers may opt for lifetime mortgages to avoid refinancing risk. Employing MAAs in remortgages could also benefit residential mortgage-backed securities (RMBS) and covered bonds.
These instruments remain key funding tools for lenders, helping banks and building societies manage liquidity, diversify funding sources and mitigate interest rate sensitivity.
The higher competition among lenders would make it cheaper and easier for existing borrowers to secure lower interest rates, thus modestly reducing defaults. On the other hand, it will also narrow loan margins, increase prepayments and reduce RMBS excess spread. While prepayments enhance credit protection for senior and mezzanine tranches, they weaken support for junior tranches that rely on excess spread to absorb losses.
Historically, prime mortgage portfolios have had faster prepayment rates than nonconforming mortgage portfolios, especially when interest rates fall or reset dates approach.
The FCA stated that the lenders are acting on its March reminder regarding the flexibility in the stress testing rules, which is helping more customers access mortgages.
The rules allow lenders to tailor the test to market conditions and use their own models, as long as they reference independent market expectations.
FCA’s stated aim is to discourage overly conservative margins in a falling rate environment, because it could limit the amount of borrowing that some otherwise creditworthy customers can access. These changes complement the FCA and Prudential Regulation Authority’s temporary modification adjustment to the loan-to-income (LTI) threshold introduced on 8 July.
The updated rule raised the de minimis threshold in annual residential mortgage lending to £150 million from £100 million. As a result, only lenders exceeding this volume remain subject to the 15% cap on high-LTI loans (LTI equal or greater than 4.5x borrower’s income), which supports competition and growth by easing constraints on smaller lenders, including building societies.
Furthermore, FCA published a draft Mortgage Rule Review: the future of the mortgage market on 25 June, which is open for comment until 26 September.
The review aims to reform responsible lending rules, expand access to later-life lending and equity release products, support first-time buyers, incorporate rental history as evidence of affordability, and adjust stress testing among other changes”. OMO Bills Yield Climbs to 24.70%, CBN Opens Auction
