Testing Times for Testing Affordability

The lending cycle for residential mortgages has moved adversely on a number of fronts, and possibly for the first time in a decade, lenders face property price falls at the same time as customers face pressure on living and borrowing costs. This brings into focus a strong need for lenders to continue to look carefully at their approach to mortgage affordability assessment for both new business and on-book exposures.

Core consumer price and base and mortgage interest rate increases, coupled with falls in property values starting to emerge, present a challenge for borrowers and a material risk for UK retail lenders. The mortgage cycle can be expected to be significantly impacted, raising the question of how to better and most accurately understand borrower affordability and how to streamline and strengthen what is a difficult-to-verify process.

In an era of increased automation and improved customer/broker experience, it’s become crucial to enhance the accuracy of affordability assessments throughout the mortgage journey. Compounding this, the collateral value of existing exposures in a downward-facing market also needs to be understood at a granular level when offering appropriately priced renewal products. Physical valuations provide this, but they impact the customer experience. Whilst still relatively commonplace at application, they tend not to be used post-completion, even if a customer’s circumstances change. Relevant in revising affordability assessments, there is a need to evidence appropriate customer outcomes, balanced alongside risk-based returns, but how can lenders be sure that customers are being offered appropriate, affordable products?

Open Banking or current account turnover data access is severely limited, or non-existent, for most lenders. Current practice tends to ‘validate’ (within reasonable bounds) customer data capture by reference to tables of averages on publicly available sources, such as the Office for National Statistics (ONS). Typically, publication of these is significantly lagged, even pre-dating the global pandemic. Consequently, they don’t reflect the events of the past 12-18 months, and certainly there is no forward-looking component, and lenders must approximate their affordability calculations – potentially propagating the averaging ‘error’. Post-completion, no such validation tends to happen on an ongoing basis, rationalised upon the previously ‘safe’ assumption that rates remain low by historical comparison and that affordability stress tests were undertaken during onboarding and the transference post application to focus on credit risk performance and loss. If customer circumstances haven’t changed notably, affordability remains good – right? Furthermore, house prices have been increasing consistently since 2008, though we are now sailing into a headwind.

To tackle these limitations and minimise customer/broker disruption, 4most has collaborated with an Income and Expenditure (I&E) data platform, where creditors ask customers to enter I&E details following a financial stress event. This data gives an accurate, up-to-date representation of what essential I&E might look like, given that this population will have expected to have already cut back on their non-essential spending.

Using this data, 4most has built an essential spend model, which can be plugged into customer decisions at appropriate points in their journey to inform affordability estimates better. This gives some fascinating insights, a unique position to understand ‘real time’ spend at a more granular level, rather than relying upon higher level averages for estimation:

• Items of expenditure a really driving household affordability issues.

• A significant accuracy uplift over ONS benchmark estimates.

• Applying an average affordability uplift adjustment across the full applicant/customer base may result in lenders:

  • overestimating income at one end of the spectrum – therefore potentially making some loans unaffordable, and

  • underestimating at the other – and missing out on lending opportunities.

In light of the formidable challenges posed by consumer price and interest rate increases, coupled with projected falls in property values, lenders need to face the challenges and carefully consider their approach to mortgage affordability assessments. By embracing forward-thinking strategies, lenders can navigate these testing times for testing affordability and emerge resilient in market challenges.