Interest rate stress test

Read more about the Financial Policy Committee's recommendations to the PRA and FCA.

In April 2014 we introduced a package of reforms to the UK mortgage market through the Mortgage Market Review (MMR).

The MMR strengthens affordability assessments to prevent consumers from taking on unaffordable mortgages and requires firms to consider the impact of likely future interest rate increases on affordability.

When doing this, lenders must consider market expectations and any prevailing Financial Policy Committee (FPC) recommendation on appropriate interest rate stress tests. 

FPC recommendations

In June 2014, the FPC made the following recommendations to the PRA and FCA:

Interest rate stress test

‘When assessing affordability, mortgage lenders should apply an interest rate stress test that assesses whether borrowers could still afford their mortgages if, at any point over the first five years of the loan, Bank Rate were to be 3 percentage points higher than the prevailing rate at origination. This recommendation is intended to be read together with the FCA requirements around considering the effect of future interest rate rises as set out in MCOB 11.6.18(2).

This is a stress test not a forecast for Bank Rate. The FCA has said it will monitor how firms have regard to this recommendation.’

The relevant rules are set out in Chapter 11.6 of the MCOB rules in our Handbook.

Read the Bank of England records of the FPC policy meetings.

Loan to income ratios

The FPC also made a recommendation about the loan to income (LTI) ratio for residential mortgages:

‘The PRA and the FCA should ensure that mortgage lenders do not extend more than 15% of their total number of new residential mortgages at loan to income ratios at or greater than 4.5. This recommendation applies to all lenders which extend residential mortgage lending in excess of £100 million per annum. The recommendation should be implemented as soon as is practicable.’

In October 2014, we published finalised guidance (FG14/8) setting out how we expect firms to act in light of the FPC’s recommendation. 

The PRA will take the lead on the LTI proposal for all lenders that they prudentially regulate. 

Read the PRA rules on LTIs.

Timeframes for taking account of the recommendations

We have not set out how quickly firms must take account of an FPC recommendation. Your firm must determine the appropriate timeframes and document these in its responsible lending policies.

Pipeline applications

We will not expect firms to re-assess pipeline cases following a recommendation if an affordability assessment has already been undertaken.

The exception is where there is a change to the pipeline case that materially affects affordability (such as an increase in borrowing).