Bank of England warns lenders of risks posed by longer mortgage terms

The Bank’s Prudential Regulation Authority cautioned lenders about increasing mortgage terms from 25 to 35 years as borrowers will have to make paymen

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.”

“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.”

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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