Fitch: Repeal of “mortgage forbearance” test increases British private sector debt

International credit rating agency Fitch said scrapping the “mortgage affordability” test that lenders advise borrowers to apply in Britain is likely to increase private sector debt.

The Bank of England’s Financial Policy Committee (FPC) confirmed last month that it will remove the recommendation to use the test from August 1, 2022.

Under the test, introduced in 2014, lenders assess whether their mortgages can be afforded if their mortgage rates rise 3 percentage points above the initially set rate at any time during the first five years of the loan.

In a statement, the agency pointed out that the increase in private sector indebtedness had weakened its rating of British banks’ financial soundness, which hovered around the “a” level.

“Some lenders may choose to maintain their current lending practices, but removing the test may allow them to extend credit to previously excluded customers,” Fitch said.

The report notes that as the fixed-rate loan transitions into a post-fixed-term bounce, more borrowers will be able to access introductory fixed-rate offers without additional collateral. Usually this rate happens after 2 or 3 years.

The report continued: With an increase in the benchmark interest rate in the United Kingdom, this could lead to an accumulation of asset quality risks.

Current bounce rates from major lenders range between 4.5% and 5% and are likely to increase in line with the base interest rate.

Lenders still need to limit loan-to-income (LTI) ratios to 4.5 or higher, while ensuring that these loans do not exceed 15% of their total loans, Fitch notes.

Fitch expects UK CPI inflation to be 9.2% at the end of 2022 and UK core inflation (excluding food, energy, alcohol and tobacco) to rise to 2.5% at the end of 2023.

The agency noted that the decision to remove the mortgage affordability test recommendation was not without risks, particularly as interest rates were rising faster than expected when the decision was made in June.