The FCA has published a paper presenting research undertaken for the 2012 Mortgage Market Review (MMR) into three potential mortgage affordability metrics. In the paper, the FCA explains which of these affordability metrics could be the most useful for future work on mortgage affordability.
The core element of the MMR recommendations – the responsible lending rules – aimed to ensure that borrowers would in future only be able to take out ‘affordable’ mortgages. During the development of the new policy and to explore its likely impact, a method was needed to measure and judge affordability, using the data available at the time.
The paper sets out the advantages and limitations of the following potential mortgage affordability metrics:
- The debt service ratio (DSR) was a simple ratio that measured the mortgage payment as a proportion of household net income (after tax and national insurance) at the time the mortgage was taken out. While its simplicity was attractive, the DSR was not able to capture important determinants of mortgage affordability – particularly household expenditure.
- The expenditure-adjusted DSR adapted the basic DSR to take into account the proportion of net income devoted to household expenditure. This type of adjusted DSR metric was an improvement over the basic DSR. However, the lack of good expenditure data and the subjectivity of deciding which expenditures to class as ‘essential’ made it unacceptable for use in policy-related analysis.
- The quality of underwriting (QoU) approach was based on an underwriting risk score. The underwriting risk score provided a usable metric, albeit with some important limitations.
For the MMR, the FCA chose a hybrid metric, based on the underwriting risk score but incorporating the DSR for some elements of the analysis. However, when looking beyond the work it carried out for the MMR, it suggests that the expenditure-adjusted DSR could provide a very useful measure for future work on mortgage affordability, if the data difficulties were overcome.