Stricter mortgage rules will end market 'excesses'

New proposals will mean one in 40 homeowners will not qualify for mortgages

Tough new proposals aimed at stamping out irresponsible mortgage lending are published today by the Financial Services Authority. After a two-year review of the mortgage market, the FSA has called for "common sense" from mortgage lenders.

The proposals, which are open for comment until March next year and would come into force in 2013, would lead to one in 40 people currently with a mortgage being unable to qualify under the new rules. But the FSA said it would introduce transitional arrangements, allowing unqualifying homeowners to remortgage as long as they have a good repayment history.

The key to the new proposals are what the FSA terms "three main principles of good lending". First is that lenders should assess affordability and only advance mortgages and loans where there is a reasonable expectation that the customer can repay without relying on uncertain future house price rises. In other words borrowers would not be allowed to bank on property inflation to increase the amount of equity they have in their home.

Next, the watchdog said the affordability assessment should allow for the possibility that interest rates might rise. Lenders will have to "stress-test" loans and calculate wither borrowers would still be able to afford them if interest rates were to rise in the next five years.

Finally, the FSA said interest-only mortgages – which have forced many people into negative equity since the start of the recession and house price slump – should be assessed on a repayment basis unless there is a strategy for repaying out of capital resources.

Lord Turner, chairman of the FSA, said: "While the excesses of the pre-crisis period have largely disappeared from the current market, it is important to ensure that better practice endures in future when memories of the crisis recede and the dangers of poor practice return."

Self-certified loans – which allowed borrowers to get a mortgage without having to prove the ability to repay – have already been outlawed by the regulator, but its new proposals will outlaw the idea of "no-advice" sales. In future borrowers will have to take advice, apart from high-net worth individuals or professionals who will be allowed to opt-out.

The proposals have largely been welcomed by lenders. Paul Smee, director general of the Council of Mortgage Lenders, said: "Rules need to be practical and avoid unintended consequences. The FSA's new proposals seem to strike broadly the right balance."

Paul Broadhead, head of mortgage policy at the Building Societies Association, said: "These proposals seem to represent a welcome shift in policy by the FSA. This is good news for the self-employed, those in existing self-certified mortgages and people with negative equity. The new regulations appear to have struck a reasonable balance between allowing lenders flexibility when assessing affordability, while maintaining a sensible level of consumer protection."

But Andrew Baddeley-Chappell, head of mortgage strategy and development at Nationwide, questioned the timing of the review. "The current mortgage market is fragile and growth is relatively weak," he said. "We question whether now is the right time to ask the industry to divert its focus on to further regulatory changes. Even more regulation, expected from the EU, is likely to result in further changes to the regulatory framework. It would be far better for the UK and European regulation to happen at the same time."