A mortgage ‘stress test’ revolves around predicting future ‘affordability’. It is seen by many borrowers as just another hurdle to overcome, but it’s important to understand why it was introduced and who it is meant to protect.

After the 2008 ‘Credit Crunch’ Governments all over the World were left supporting insolvent or near insolvent banks that had seen their balance sheets crumble overnight. In large part, this was driven by a crash in house prices in North America and elsewhere. And the reason for this was determined to be irresponsible lending to people on low interest rates, who were later found to be either unable or unwilling to pay their mortgages.

In the UK, pre 2008, it was normal for borrowers to borrow 100% of the purchase price of their new home, sometimes even more than 100%, with extra money being lent for consumer goods, cars and holidays, based on the expectation that the housing market would keep rising in value!

Post 2008 the UK Government laid down new regulations requiring mortgage lenders to adhere to a variety of policies relating to their lending practices, probably the most important of which was the mortgage stress test.

Mortgage lenders usually require a deposit be put down by buyers these days. It may be relatively small, but it’s not insignificant. The Government also offer assistance to certain buyers looking to buy new homes or get onto the ‘housing ladder’. However, the stress test must still be run by lenders and loans are dependent upon them being passed.

A Stress Test will usually look at several factors, most specifically, whether or not a borrower can still meet the monthly repayments of their mortgage and all other necessary budgeted expenditure if mortgage rates were to rise by a specified amount. This is particularly important where when mortgage interest rates remain historically low.

Following the Bank of England’s Stability Report in 2017, lenders are required to stress test mortgages at 3% above the rate at which fixed or capped rate loans will revert or 3% above the lender’s Standard Variable Rate (SVR). If the SVR of a lender is say 4.75% then the stress test might be conducted assuming a notional interest rate of 7.75%.

The test is conducted by applying such increases in the monthly mortgage repayment against the lenders monthly budget. This is why lenders are now required to detail their income and their expenditure when applying for a mortgage.