What is a mortgage stress test?

If you’re getting ready to buy your first home, it helps to know what lenders look for when you apply for a mortgage.

One thing they check is whether you could still afford your mortgage if interest rates changed – this is called a stress test.

Read on to learn what a stress test is – and why it matters.

What is a stress test?

A mortgage stress test is when a lender checks whether you’d still be able to manage your mortgage payments if interest rates go up. Think of it as a ‘what if’ scenario - they want to make sure you won't be struggling if your payments suddenly increased. Lenders will usually check if you could still pay your mortgage if the interest rate went up by 2%, although this rate varies on the provider and the type of mortgage you’re looking at.

What can you afford?

When you’re shopping around for a mortgage, you shouldn’t just be looking for a lender who will let you borrow enough, but also for a deal that you can afford. After all, your dream home may feel like less of a dream if you struggle to pay for it and have no money left over for anything else.

Lending regulations

Lenders must follow rules set by the Financial Conduct Authority (FCA). These rules say they have to check if you can afford your mortgage right now – as well as if interest rates go up in the future (this also applies to other forms of loans).

The FCA states that lenders must consider the impact of likely future interest rate rises for a minimum period of five years. The exceptions for this are if the remaining mortgage is for less than five years, or if the interest rate is fixed for five years.

If a lender thinks you’d struggle to pay now, or later, they won’t offer you the mortgage.

Using mortgage calculators

A mortgage calculator can help you work out how much the mortgage you want is going to cost. You can also check how much payments could go up if interest rates were to rise.

As an example, if you wanted to borrow £250,000 over 25 years with an APR of 4.5%, this would cost you approximately £1,390 per month. However, if interest rates went up by 2%, this would change to £1,690 each month.

You need to be sure that you can pay your mortgage and cover all your other outgoings, like utility bills, buildings and contents insurance, groceries, petrol, and so on.

If a lender thinks you won’t have enough money left over after paying your other costs, they might not approve your application. 

Why’s it important to stress test?

The reason it’s important for lenders to carry out a stress test is that you may be able to afford the mortgage deal you’re applying for now, you may face difficulty if rates go up. If this happened, you might have to make drastic cutbacks to afford your mortgage. You may even risk missing a mortgage payment, which puts your home at risk of repossession.

In recent years, the Bank of England has raised its base rate. This has made many mortgages more expensive, with some people paying hundreds of pounds extra each month.

It’s not only the base rate changing that could mean you pay more though. Most mortgage deals last between two and five. Once this deal comes to an end, you will automatically be moved on to the standard variable rate (SVR), which is your lender’s own rate.

You can choose to sign up to a new deal at this point, but until you do, you’ll be charged the SVR – and this can be quite a lot more than the original rate you signed up to.

Again, this can put you in a difficult situation where affording your mortgage is a struggle, This is why it’s important to be aware of your lender’s SVR and when your current deal ends, so you can start shopping around for a new one in good time.

While a stress test might sound scary, it’s there to protect you. It helps make sure your mortgage stays affordable – even if things change.