The regulation of mortgage lending is key in determining the level to which buyers are able to stretch themselves to get on the housing ladder.
As part of the Government’s drive towards economic growth, two regulatory changes have been made which should allow buyers to access more debt and should increase the demand for housing:
- In March, the FCA released guidance advising that banks were taking an overly cautious approach to stress testing, and since then, most major lenders have loosened their criteria.
- More recently in the July Financial Stability Report, the Bank of England recommended a relaxation in the loan-to-income (LTI) flow limit, to allow individual lenders to have more than 15% of their new mortgages at an LTI of more than 4.5, although the sector average should remain below 15%. We think this is likely to increase house price growth and transaction numbers over the next five years.
Getting into the weeds
Stress testing involves making sure borrowers could continue paying their mortgage if their circumstances worsened. The FCA rules state that when stress testing, lenders must have regard for the likely future interest rate which the borrower will be paying. This has previously been taken to mean the very high reversionary rate which most mortgages default to after their fixed term.
But where a borrower is likely to move onto another fixed rate (which the majority do), the FCA have suggested that it is that future fixed rate against which it is appropriate to test, particularly in an environment where the risk of a significant increase in interest rates is relatively low.
A less onerous stress test means that some borrowers are able to take on higher levels of debt relative to their incomes. Lenders have reduced their stress tests by an average of 110 basis points since the guidance, according to the Bank of England, and lenders’ own estimates suggest this allows for between £14,000 and £40,000 of additional borrowing for the average buyer.
Lending is still constrained by the FCA’s LTI flow limit, which currently states that no more than 15% of a lender’s new loans can be at an LTI of over 4.5. In reality, most lenders give themselves a buffer against this measure, meaning the sector average is just less than 10%, according to the Bank of England. But the Bank has recommended that this rule changes to allow individual lenders to increase their share of high-LTI loans to more than 15%, as long as the sector as a whole remains below that level.
What impact will this have?
These changes will together allow for an increase in the amount of debt buyers can take on relative to their incomes, meaning they require a smaller deposit to buy. This should help both first time buyers and upsizers, potentially increasing transaction levels. But some of this additional borrowing potential might also go towards house price growth, particularly if there isn’t a high volume of stock on the market.
There are very few recent situations where we can look at how a change in borrowing capacity impacted the market. One comparison is the beginning of the Help to Buy scheme, where buyers were able to borrow more to buy new homes. In the seven years after the scheme was introduced, new homes increased in value more quickly than second hand homes (39% growth vs 29% according to the Land Registry). And transaction levels for new homes grew consistently, whilst sales of second hand homes did not.
But the incomes of buyers also increased more quickly in the new build market, according to Experian data. This suggests that an increase in borrowing capacity would likely have some inflationary impact on house prices over a period of a few years at least, and would also generate additional transactions. But the evidence suggests it may not allow those with lower incomes to buy in large numbers.
The additional 10% price growth under Help to Buy gives us a rough benchmark to work with. But we think the impact this time round is likely to be some way less than this, because the scale of the regulatory change is smaller. Under HtB, any number of buyers could access additional lending of up to 20% of their purchase price and could do so with just a 5% deposit. The current changes do allow an increase in borrowing relative to incomes, but this is not likely to be as much as 20% of the price, and can only have an impact on, at most, 5% of new mortgages (assuming the industry average for high-LTI lending reaches 15% of loans from its current level of 10%). Banks are also remaining cautious, only decreasing their average stress test rate by 110 basis points, when further decreases would be possible under the regulation.
We have therefore increased our house price forecast for 2027-29 by 5.5%, from 13% to 18.5%, partly because of the regulatory changes, but also because the weaker-than-anticipated housing market in 2025 leaves greater capacity for price growth in later years. As with Help to Buy, we think it will take a period of years for the changes to fully feed through into activity and pricing.
Additional price growth remaining moderate means there is capacity for transaction volumes to increase. We think transactions are likely to increase to just below their post-GFC average of 1.2 million between 2027 and 2029, with an improving mortgage market and looser lending requirements being set against the absence of a buyer support scheme like Help to Buy.
There is particular capacity for more transactions from mortgaged home movers, amongst whom activity has been weak for the last three years. This will aid supply by generating additional stock as this group looks to sell and move. These changes are likely to have a larger impact in the more affordability-constrained markets of London and the South, where buyers are more likely to come up against the limits of what they can borrow.
Given the uncertain economic backdrop in 2025, we expect the market to remain relatively slow in the short term. But these changes to regulation suggest that the housing market may have a smoother road ahead.
Contact one of our highly experienced mortgage advisors today on 0121 500 6316 to discuss your mortgage needs.
