New mortgage rules were introduced in the UK this week by the Financial Conduct Authority. They could make life much tougher for you if you are about to buy a house or re-mortgage. However, they could also help you gain control of your finances, give you a deeper understanding of your money and, literally, help you sleep at night.
What’s in the new mortgage rules?
The new mortgage rules set strict new lending criteria and require your lender to carry out a detailed assessment of your cash flow when you apply for a mortgage. You will be asked searching questions about your household income and expenditure, and you will need to provide evidence. In addition, you will be subjected to stringent stress tests to assess your ability to maintain mortgage payments in the event of a rise in interest rates. Typically, a lender may project interest rates rising to, say three and a half percent over the next five years, and will test at double that – seven percent.
So if you are about to apply for a mortgage, can you provide that evidence? Do you think you will pass the lender’s stress test? Time to get out the back bank and credit card statements and the calculator.
Fallout from the financial crisis
This is just one more side effect of the 2008 financial crisis. Households with large mortgages really came under pressure as house prices and incomes fell in the crisis aftermath. Many struggling to keep up repayments. This was a ‘balance sheet recession’, the longest and most difficult type of recession precipitated by high levels of debt and low or negative net worth. To get out of it, households had to divert income away from spending and back into debt repayment and rebuilding their balance sheets, a long process which the FCA, as one of the guardians of the nation’s economic health, does not want to see happen again, hence the new mortgage rules.
The art of financial planning
I understand that some families on the verge of purchasing a property may now be very disappointed at having to rethink their plans. However, this back door validation by the FCA of what is in effect the financial planning process that I and fellow planners have advocated for so many years is to be welcomed. Over the years I have sat with many couples in my office who have come to me because they had overextended into property and, if not at that moment in difficulty, were asset rich and cash poor, and not in a good place.
Financial planning is a process that provides proven and rapid results in the form of more efficient portfolios, peace of mind, and more efficient and faster achievement of life and financial goals.
A key part of the process is assessing expenditure, building spending plans and monitoring them, an exercise for which apps such as Moneydance, Moneywiz and iBank are invaluable. Another part of the process is building life time cash flows and using them to model both shocks and scenarios. What if this happens, what if that happens?
From now on applying for a mortgage under the new mortgage rules will be more like applying for a business loan. When you visit your lender you will need to be armed with a realistic request for a loan, historic and projected cash flows, and effective contingency plans – all elements of the financial planning process.
A return to financial prudence
The new mortgage rules are likely to result in an increase in savings – one of the three pillars of a good financial plan – as it becomes clear that a lower loan to value ratio will help to obtain mortgage finance. It will also lead to stronger household balance sheets and greater financial security. Whilst the new regime may seem hard now, it is likely to lead to much improved economic and financial stability.