UK’s FSA issues Mortgage Market Review: Proposed Package of Reforms

Date Published 2/3/2012
Author Marja Hoek-Smit
Theme Housing Finance Policy
Country United Kingdom

January 15, 2012

At the end of 2011 the Financial Services Authority of the United Kingdom, published its proposals for reforms of the mortgage sector. It is soliciting comments which should be in by March 30, 2012. It is a hefty document with close to 600 pages. At the core of the proposed reforms are three principles of good mortgage underwriting:

  • Mortgages and loans should only be advanced where there is a reasonable expectation that the customer can repay without relying on uncertain future house price rises. Lenders should assess affordability.
  • This affordability assessment should allow for the possibility that interest rates might rise in future: borrowers should not enter contracts which are only affordable on the assumption that low initial interest rates will last forever.
  • Interest-only mortgages should be assessed on a repayment basis unless there is a believable strategy for repaying out of capital resources that do not rely on the assumption that house prices will rise.

At the core of the responsible lending proposals is the principle of affordability, rather than relying to a significant extent on the underlying collateral and the assumption that property prices appreciate. This principle has three key elements:

  • The affordability assessment: a lender must verify income and be able to demonstrate that the mortgage is affordable taking into account the borrower’s net income and, as a minimum, both the borrower’s committed expenditure (which includes the mortgage payments) and basic household expenditure.
  • The interest rate stress test: the lender must also take account of the impact on mortgage payments of market expectations of future interest rate increases.
  • The interest-only proposals: the lender must also assess affordability on a capital and interest basis, unless there is a clearly understood and believable alternative source of capital repayment.
No LTV caps are proposed.

While recognizing the other initiatives by the European Union and the Financial Stability Board/BIS to establish a regulatory framework for the mortgage sector (see earlier news posts), it is recognized that these proposals take a higher level approach than the FSA, but are, in principle, closely aligned.

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