The Financial Policy Committee’s (FPC’s) mortgage market Recommendations, introduced in 2014, are designed to limit the number of highly indebted households.
In general, a borrower who wants a mortgage to buy a home will be constrained by how much they have saved and how much they earn. Lenders’ loan to value (LTV) limits will determine how much they can borrow, given their deposit. FPC policy and lenders’ internal limits determine how much they can borrow relative to their incomes.
Chart A illustrates how the size of deposit determines which of these constraints might bind for a typical household with an income of £30,000, the average household income of renters in the Wealth and Assets Survey. The red line shows the maximum amount they could borrow at each deposit level, assuming lenders require a 5% deposit. The purple line shows the maximum loan they might be able to obtain given their income under the FPC’s affordability test Recommendation. Under the affordability test, a borrower must have enough income to afford their mortgage repayments even if interest rates rise by 3% above their contractual reversion rate.
Chart A: Lending constraints on a household with the UK average income of £30,000
- Source: Bank calculations.
For a borrower with a relatively low deposit, the mortgage they can get – and therefore the properties they can buy – is constrained by their deposit. But as their deposit increases, the affordability test begins to limit the largest mortgage they can get.
Under our assumptions, a borrower with a deposit of less than around a quarter of their income is likely to be constrained by lenders’ LTV rules, not the affordability test.
Using data on incomes and savings from the latest wave of the Wealth and Assets Survey, we have estimated the share of renters currently constrained in the amount they can borrow by LTV limits versus the FPC’s affordability test (Chart B).
Chart B: Rental households tend to be constrained by lenders’ LTV limits rather than FPC policy
Household income versus liquid assets and ability to pass lenders’ requirement of 5% deposit
- Sources: Wealth and Assets Survey (ONS) and Bank calculations.
We estimate that LTV limits are likely to constrain the amount that can be borrowed for about 75% of renters. These borrowers would likely pass the affordability test for any home on which they could afford a 5% minimum deposit.
The remaining 25% are in principle constrained in the amount they can borrow by their income. There are properties on which they could afford a 5% deposit but might not pass the affordability test. For example, someone with savings of £10,000 and a £30,000 income could afford a 5% deposit on a £200,000 home. But they could only borrow up to around £150,000 without failing the affordability test.
Of course, not all renters want to buy a property, or wish to borrow the maximum loan available to them. They may also have alternative sources of deposits, which we have not accounted for, such as contributions from friends and family.
This post has been prepared with the help of Lisa Panigrahi and Simon Pittaway.
This analysis was presented to the FPC in December 2020.
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