UK scraps mortgage buffers

The UK’s central bank, Bank of England (BOE) has relaxed the requirement for borrowers to be assessed for a potential 3 percentage point increase in mortgage rates, which has sparked questions over whether APRA will follow suit.

From this month, lenders only need to assess for a minimum stress buffer of 1 percentage point, but rising power bills will also still need to be factored in.

With inflation running hot in the UK, the BoE has been lifting its cash rate since December and bumped the cash rate up 50 bps in August, taking it to 1.75 per cent.

Much like in Australia, UK’s central bank indicated that it would “take whatever actions are necessary to bring inflation down to 2 per cent”, which has now tipped 9.4 per cent in June, and is expected to peak at “around 13 per cent”.

Given the rising cost of living and lending barriers, the BoE made the decision to withdraw the buffer test in June, which has come into effect as of Monday, 1 August.

While it may seem counter-intuitive as the buffers work to protect the borrower, the lender and the economy, they also pose a barrier to lending, particularly as the cost of borrowing increases.

Similar to Australia, the buffer was used by lenders to establish whether prospective buyers could afford monthly remortgage payments on the cost of the property.

Lenders not only had to work out whether buyers could afford the current cost of the mortgage, but also if they could still afford repayments if interest rates were to increase 3 percentage points above the interest rate.

Borrowers who could not prove they could manage financially with the increase might have been turned down for a loan, even if they could afford the current mortgage. 

BuyersBuyers urges APRA to review buffers

Real estate agent network BuyersBuyers said a rigid buffer “starves the market” of funds, making “refinancing unfeasible” for many mortgagors, and unnecessarily “prices out” many first home buyers.

Thus with Australia’s cash rate at 1.85 per cent and set to rise, the network said the equivalent stress test in place in Australia “should also come under scrutiny next month”.

In early October 2021, the Australian Prudential Regulation Authority (APRA) introduced a requirement for a lending assessment buffer of at least 300 bps, which required lenders to assess borrowers’ loan repayments 3.0 percentage points above the loan product rate.

But with the cash rate set tip rise 2 per cent next month, BuyersBuyers co-founder Pete Wargent said it was unrealistic to assess borrowers with such a high rate.

“Realistically the cash rate target is extremely unlikely to increase to anywhere near the implied 5.35 per cent in the current monetary tightening cycle,” Mr Wargent said.

“Assessing borrowers at such extreme outcomes would thus be unnecessary, at a time when Australia is close to experiencing full employment, and rental vacancy rates are tracking at near 20-year lows.”

Despite refinances hitting new records in June ($12.7 billion) according to the Australian Bureau of Statistics, Mr Wargent said some clients had also struggled to refinance, which had left them “stuck with unattractive mortgage rates” or on challenging repayment terms.

“The ability to ensure existing borrowers have access to refinance is a critical safety valve for the housing market and for financial stability,” Mr Wargent said.

BuyersBuyers chief executive Doron Peleg added such a large stress test would no longer make sense, especially with the banking system so well capitalised.

“A buffer of, say, 2 percentage points would be far more appropriate now, not least because the current rules make it far too difficult for many borrowers to switch lenders, often leaving them trapped on unattractive mortgage rates and poor terms,” Mr Peleg said.

[Related: DTI limits and buffers in APRA’s arsenal to manage credit risk]