It’s February, it’s miserable, the days are getting a wee bit longer, but not much. It’s time to think about holidays, get something in the diary to look forward to. And most of the planning is great. City break, ski, beach or an adventure? But, its not all fun in the sun. Once we start signing on the line, we are simultaneously worst-case scenario planning. We take out insurance in case we’re ill and have to cancel, in case we break a leg, in case we lose all our luggage and have to improvise a new holiday wardrobe, in case we get food poisoning and have to fly home early. We take contingency planning very seriously – even if it is only a quick flip to France.
On the other hand, we until recently, made what could be a life-changing decision without a backwards – or forwards – glance. We took out mortgages without planning for the worst case scenario. And sometimes, there were very bad scenarios indeed – whether it was unexpected interest hikes or the loss of a job.
In June 2014 the Bank of England’s Financial Policy Committee (FPC), which monitors the UK economy, addressed the situation by putting in place recommendations for lenders which stated that:
“When assessing affordability, mortgage lenders should apply an interest rate stress test that assesses whether borrowers could still afford their mortgages if, at any point over the first five years of the loan, Bank Rate were to be 3 percentage points higher than the prevailing rate at origination.”
This is effectively a simple and sensible stress test for mortgage brokers and lenders to use to assess their customer’s financial capability – or their ability to honour their mortgage payments should interest rates increase.
And since then, lenders have used the stress test efficiently and responsibly with their clients. However, after having their regular spending and transactional data on their bank statements analysed by their lenders, tens of thousands of customers across the country have failed the test and been turned away for a mortgage.
At Castlight, we wholeheartedly endorse the principle of worst-case scenario planning when taking on a mortgage. It’s part of what we do – empowering people to manage their finances and make good decisions.
However, we also believe that many thousands of customers would not have failed the stress test if they had had access to our Affordability Passport®. As you will know, if you’ve been following this series, the Affordability Passport® allows clients to share the detail of their transactional data with their lender in real time. And at the touch of a button, spending is categorised into tens of categories, but most importantly it is categorised into what is discretionary spending and what is not. This might flag up a discretionary carry out pizza habit, an expensive, barely used gym membership, a reluctance to bring a sandwich into work or too many nights out. Nice though all these things are, they are easily curtailed and could make the difference between someone passing or failing an interest rate stress test.
Armed with the considerable level of transactional detail provided by the Affordability Passport®, both the borrower and lender might be able to see that, if some of life’s little luxuries were cut out, the borrower’s outgoings would be sufficiently reduced to pass the stress test. Of course, the Affordability Passport® will also make very clear that some people will have no fat to trim and that’s useful information too.
The FCA’s interest-rate stress test is a very useful tool for worst-case scenario planning. Use it in conjunction with Castlight’s Affordability Passport® and you have a truly insightful and reliable answer as to whether or not a mortgage is affordable.
And there might even be enough dough for the occasional pizza too!