Announced today are changes to the way UK Banks will assess affordability for borrowings.
Moving away from only looking at gross multipliers of income UK Banks will now adopt a more focused view on overall affordability when assessing a mortgage application for financial approval.
What are the key changes to risk assessment in UK
Previously UK Banks rarely took into account the monthly outgoings an applicant had, or took into account that based on the term the client wanted, what impact this would have on disposable incomes.
The move toward affordability ratios is far more in line with the way Spanish Banks have assessed lending for many years.
In Spain the monthly payments made on loans and mortgages are expected to not exceed around 35% of net incomes. Only incomes after deductions are assessed and the use of affordability ratios also has an impact on the overall minimum term the loan could be run over.
In Spain however, unlike the UK, as reported in the news today Spanish Banks do not assess other expenditure outside mortgages and loans. Spanish Banks take no account of lifestyle expenditure on the basis these are not commitments that have to maintain.
It is interesting to see that in complete reverse UK Banks may now take into account other expenditure such as pension contributions, mobile phones and leisure activity costs even though all of these could be removed from the household expenditure if required at a later date.
Why move toward a Spanish mortgage style risk assessment
Despite for years the Spanish Banks assessing on the more relevant affordability ratios, mortgages in Spain for UK residents have much higher default percentages than within the UK mortgage market. It could therefore be argued that there will be little or no benefit for the UK lenders to move in this direction.
The issues for the Spanish Banks historically has not however been that affordability ratios do not work when underwriting. With Spanish Banks the issues were they did not undertake a high enough level of due diligence to check the validity of the documents they were presented with. Secondly Spanish Banks believed someone buying in Spain who was employed, with a simple financial structure of pay slips and a P60, but on average earnings was a better risk than a more financially complex client who was tax efficient but still maintained high levels of disposable incomes after all loans were paid.
Assessment of mortgage affordability against a benchmark interest rate
The second part of the new rules in the UK is that lenders must also assess clients against a rising interest market meaning they should check affordability against a rate of 7% rather than prevailing rates. This is another area where Spain was ahead of the game. Many Spanish Banks whilst not necessarily taking a benchmark interest rate figure by which to assess ,will allow for future rate increases by only taking into account either a percentage of a clients net income and or divide the year by 14 months rather than 12.
Other Spanish Banks have used benchmark rates as is being applied now in the UK.
UK mortgage applications will reflect more closely Spanish Mortgages
It is interesting to see that the new rules bring UK loan assessment more akin to Spanish mortgages and may help UK applicants in Spain understand more fully how their application will be viewed by Spanish Lenders as the two processes move more closely together.
For nonresident mortgage applications in Spain it is also the case that normally the purchase is a second home and therefore risk assessment, pricing and loan to values reflect this. It is a proven fact that the default situation on second homes is much higher than on main residence and that mortgagees are more likely to default in a financially difficult period on their second home mortgage than on their main residence.
Whilst pricing in Spain remains historically high despite some new best buy loans being launched it must be borne in mind that Spanish Banks are lending to the second home market and assuming the risks that go with this.
Are the changes to mortgage lending good or bad news
Whether finally the new rules in UK have a positive or negative impact on loan approvals and whether finally the new rules dampen demand in the UK as long as Banks do not follow the guidelines blindly, and take a pragmatic view of flexible expenditure it is surely better to assess clients on affordability ratios than to just look at gross multipliers of income.