The Bank of England has warned mortgage lenders of the possible risks posed by the recent trend of longer loan terms.
The Bank’s Prudential Regulation Authority cautioned lenders about increasing mortgage terms from 25 to 35 years as borrowers will have to make payments from post-retirement income.
Sam Woods, head of the Prudential Regulation Authority, said that while the Mortgage Market Review had put affordability at the heart of mortgage lending decisions “complying with the spirit as well as the letter of the law is important”.
The speech was originally planned to be delivered at the Building Societies Association conference in May, but was postponed due to the election.
Woods highlighted the recent trend of mortgage terms rising from 25 years to 35 years or “even longer”.
He said: “Of course, increasing the term reduces the level of each monthly instalment and makes the loan more affordable in the short term; however, it also increases the total amount of interest paid over the life of the loan quite significantly, and it increases the possibility that the final instalments may have to be met from post-retirement income.
“That should not be a problem if lenders can be confident about the availability of such retirement income, or about the scope for the borrower to downsize and use the sale proceeds to pay off the balance of the loan.”
While a mortgage is typically taken out for 20 to 25 years, first-time buyers are increasingly taking out mortgages for longer terms due to soaring house prices and deposits.
By doing this you can reduce your repayments as they are spread out over a greater number of months. However, this means you end up paying interest for longer, which increases the cost of your loan.
“If lenders become too narrowly pre-occupied with the profile of the loan in the first five years – in line with MMR affordability rules – this could store up a problem for the future,” Woods said.
He noted that the PRA had observed a number of lenders taking greater risks to attract more borrowers as a result of increased competition in the sector.
“Across the wider market, we are observing – not from all firms, but definitely from a few – a shift in credit risk appetite as lenders compete with each other to find ways of widening the pool of available borrowers, increasing the size of loans available to them, or reducing the credit premium charged for inherently more risky loans,” Woods said.
The news comes after the Bank confirmed last week that it was tightening its mortgage affordability rules.
In its latest Financial Stability Report the Bank said lenders will now be required to check that a borrower can pay back their loan at a rate of 3% above the standard variable rate.
Under the previous rule introduced in 2014, banks and building societies would test borrowers by checking how they would react to an increase of 3% above the base rate.
With the average standard variable rate above 4%, this means borrowers could have their affordability tested at a rate higher than 7%.
The Bank told Britain’s lenders that they must set aside £11.4 billion of capital in the next 18 months to make them more resilient to the risk of rising consumer debt.
It said it would increase the counter cyclical capital buffer from 0% to 0.5% and suggested this will likely go up to 1% in November.
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While I appreciate Sam Woods’ concern, I think this ignores the realities most in their 20s / 30s live with – the retirement age will be pushed back significantly. At present you can claim the state pension at the age of 65. I know at the age of 32 this will be pushed back to 70 before too long and likely older still.
It also ignores some relatively fundamental considerations. Britain is an island – thus limited land for development. The planning system tightly controls its release. As the population grows (thanks to a combination of immigration, aging population etc), the number of people chasing homes will grow. Provided there are enough properties to downsize too, this mismatch between supply and demand will push prices one way, in the long-term – up. The effect will be heightened in some parts of the country but it will mean increased levels of equity and reducing loan to value ratios over time, thus more affordable repayments.
In short safe as houses is still applicable irrespective of mortgage term.
This also assumes that the applicants will remain in the property for the 30-35 years without moving and/or without making any changes to their Mortgage in subsequent years. Whilst I appreciate some may well do this, I would argue the vast majority would be moving on at some stage in this 30-35 years term, or at least re-mortgaging/reviewing arrangements where further discussions would take place around their plans, circumstances, affordability, retirement plans, Mortgage term etc.