THE BLOG

Defusing an 'Affordability Timebomb'

19/06/2014 16:16 BST | Updated 19/08/2014 10:59 BST

Perhaps one of the most positive outcomes of the recent economic crisis was the message that consumers would benefit from saving more and borrowing more responsibly. So accessible were interest free loans, 105% mortgages and credit accounts that consumers came to believe they could afford anything, irrespective of their financial circumstances.

A culture was created where aspiring homeowners purchased homes they never imagined they could afford, families holidayed a little further afield and for a little longer than their bank balances suggested should be possible, and consumers purchased the latest smart phones, TVs and stereo systems with little regard for the date of their next pay day.

This 'buy now, pay later' culture seduced the nation and created a population of asset and technology rich but cash poor and debt-heavy consumers. When the credit finally ran dry and the nation's finances were laid bare, the realisation dawned that much of the population had been living beyond their means.

This news came as a shock to many and those lenders who had once offered the world on an interest-free platter were forced to tighten their lending belts. Loans and credit would only be offered to those who were actually able to afford the repayments and mortgage lending would return to being assessed against stringent affordability criteria.

This renewed collective pledge to only lend where appropriate was a positive outcome of the downturn. Those of us who'd steered clear of loose-lending in the first place were particularly satisfied that the industry would return to being governed by common sense and a commitment to the basic principles of affordability.

Today, credit checks are more stringent, lending criteria is stricter and financial circumstances are more closely assessed before money is lent and mortgages are given the green light. These moves, coupled with greater consumer awareness of the pitfalls of spending beyond our means, point to a redressing of the nation's debt versus equity imbalance and a future of economic prosperity.

Sounds great, doesn't it? But is this really reflective of where we're heading? If you ask me, more needs to be done if we are to avoid revisiting the hardship of recent years.

The crux of the issue lies in the interpretation of the term 'affordable'.

It's no secret that the UK is currently operating in a low interest rate environment. While savers have watched on as their savings balances haven't risen as they'd like, borrowers and mortgage holders have never had it so good. Unfortunately, that's the way things work as there has to be a balance between the two. Financial conditions invariably either favour the saver or the borrower.

It's never been so cheap to borrow money and, if lent responsibly, those who have recently taken out a loan or a mortgage have likely done so at an extremely competitive rate. That's all well and good and there's no denying that this has delivered a welcomed boost to the economy and the housing market in particular.

The concern, however, is that inevitably interest rates won't stay this low forever. Forecasts suggest interest rates will soon start to increase and will continue to rise thereafter. This begs the question; will a loan that's affordable today be affordable tomorrow, when interest rates start their ascent?

Assessing affordability is a complex process which demands attention. Of course, it's never nice for a financial services provider to have to turn down a loan or mortgage request but refusing a mortgage request or limiting the loan-to-value on offer is always a better option than having to repossess a property in the future.

It is clear that the Bank of England is aware of the negative impact that rapidly increasing interest rates would have on the economy, so although we can expect a rise in interest rates, it will be at a much slower rate than previously.

Thankfully, the issue of affordability is being addressed and the recent Mortgage Market Review (MMR) regulations have been implemented to safeguard consumers from taking out loans they cannot afford. These rules will force all lenders to more closely assess their applicants' spending habits to get a fuller picture of whether a repayment schedule is realistic. The MMR has been brought in to enforce responsible lending.

Responsible lending is about looking into the future and carefully assessing whether a loan that is affordable today will be affordable as economic conditions evolve. It's about considering projected trends in UK salaries and evaluating these against likely movements in interest rates to gauge a borrower's future economic conditions. In short, responsible lending is about only lending to those borrowers that will realistically be in a position to repay their loans.

If sanctioned responsibly, loans and mortgages are an important financial tool which can improve lives. If handed out without due care and diligence, loans and mortgages can lead to financial turmoil. The MMR regulations are a positive step which should help to ensure that mortgages are only given to those who will be able to afford the repayments in good times and in bad. This can only be good news and should go some way to safely disposing of the ticking affordability timebomb.