Buying a home is a dream for many people, but it can be a daunting process, especially in today’s economic climate. One of the most important factors to consider when buying a home is your mortgage affordability.
Mortgage affordability is simply a test to show you have the ability to make monthly repayments on time and in full.
In the UK, mortgage lenders use a number of factors to assess your mortgage affordability, including your income, debts, expenses, deposit, and employment status.
In this blog post, we will delve into the intricacies of mortgage affordability criteria in the UK and shed light on the factors that lenders consider when assessing your mortgage application.
Disclaimer: I’m not a mortgage advisor or mortgage broker. Everything I say in this blog post comes from my experience as a homeowner who went through this not too long ago and from research.
A mortgage is essentially a loan used to purchase a home, and the Financial Conduct Authority (FCA) requires mortgage lenders to determine whether or not a borrower will be able to repay the loan.
To achieve this mortgage lenders will conduct an affordability assessment in order to ensure that you can repay the loan.
The assessment of mortgage affordability involves several critical elements, each of which has its impact on the overall decision-making process.
This rule is a common benchmark used to assess whether a borrower can afford a particular mortgage payment.
This rule suggests that no more than 35% of your net income or take-home pay should go towards your monthly mortgage payments.
The reality is many in the UK especially those living in London won’t pass this test, where they are currently paying close to 50% of net income on rent.
For example, if you take home £2,000 per month after taxes, the 35% rule would suggest that you should spend no more than £700 on your monthly mortgage payment.
Traditionally, lenders have relied on annual income multiples to calculate how much a borrower can borrow. Typically, they consider income multiples of around 4x to 5x the borrower’s income.
For example, If you have a gross annual income of £50,000, with an income multiple of 4 the maximum mortgage you can borrow is £200,000.
While many mortgage lenders use a form of multiple income either 3x, 4x or 5x, it’s important to note that they all still carry out a more stringent affordability check that involves your
Committed expenses are often overlooked by many borrowers when assessing their mortgage affordability.
These monthly outgoings include credit cards, personal loans, childcare costs, utilities, food and other financial obligations.
Lenders thoroughly examine these commitments as they significantly affect the amount the borrower can borrow.
This is why it’s crucial to have a budget and track your living expenses.
The debt-to-income ratio is a number that shows how much of your income goes towards paying off debt. Lenders use this number to decide how much money you can borrow.
To calculate your debt-to-income ratio, add up all of your monthly debt payments, including credit card payments, student loans, car loans, and any other outstanding debts. Then, divide that number by your gross monthly income. Multiply the result by 100 to express the debt-to-income ratio as a percentage.
A lower debt-to-income ratio is better, because it means that you have more money left over after paying off debt.
For example, if your monthly debt payments total £1,000 and your gross monthly income is £3,000, your debt-to-income ratio would be 33.33%.
So if you are looking to buy a house, it’s important to reduce your debt obligations.
A loan-to-value ratio (LTV) is a measure of how much of a property’s value is being borrowed.
A higher LTV means that the borrower is borrowing more money, which is riskier for the lender. This is because if the property value goes down, the borrower could owe more money than the property is worth
Lenders prefer borrowers with a lower LTV because it means that there is less risk of the borrower defaulting on the loan. This is because the borrower has more equity in the property, which means that they have more to lose if they default.
That is why the 100% mortgage by Skipton Building Society was met with criticism
For example, if a property is worth £100,000 and the borrower is borrowing £80,000, the LTV is 80%.
If the property value then goes down to £90,000, the borrower would still have £10,000 of equity in the property.
However, if the LTV was 90%, the borrower would have no equity in the property and would be in negative equity.
As we’ve already said, lenders can use multiples of your income, but how they treat you depends on what kind of job you have. This means that someone who works full time will be treated differently than someone who works for themselves (self-employed)
In reality, lenders are much more cautious when calculating affordability for those with self-employment.
Lastly, not every full-time job is the same. Some lenders will give people with jobs like doctors and lawyers between the ages of 25 and 40 a higher income multiple, sometimes up to 6x their income
A credit report is a crucial component of mortgage affordability, as it provides lenders with valuable insights into a borrower’s creditworthiness and financial behaviour.
A positive credit history and high credit score can lead to loan approval, lower interest mortgage rates, and more favorable loan terms.
Prospective homebuyers should actively monitor their credit file, rectify any errors, and work towards improving their creditworthiness to enhance their chances of securing a mortgage and achieving their homeownership dreams.
Interest rates play a significant role in mortgage affordability. With a higher interest rate as a result of the increase in Bank of England base rate, borrowers must be prepared for potential increases in their monthly mortgage repayments.
For instance, even a slight increase in mortgage interest rate can cause a significant rise in monthly payments, putting a strain on the borrower’s finances.
The mortgage stress test is another thing that comes into play, this test helps determine if a borrower could still afford their mortgage payments if interest rates were to rise in the future, like we are experiencing now. The idea here is to protect borrowers from defaulting on their loans.
Personally it’s advisable to always apply a stringent stress test when taking out a mortgage, this will make you harder to kill if the economy goes south like it is at the moment
It simply means asking yourself something like if the interest rate goes to 10 per cent would you still be able to make your payments
To increase their mortgage affordability, prospective borrowers can take several steps to strengthen their financial position:
Mortgage lenders consider various sources of income when assessing affordability, and this includes commissions and bonuses.
However, it’s important to note that not all lenders treat these types of income the same way, and their approach may vary based on the lender’s policies and the borrower’s individual financial circumstances.
Some key points to consider are consistency of Income, evidence of earnings and bonus type
There are a number of different types of mortgages available, each with its own advantages and disadvantages. The most common types of mortgages include:
There are a number of different mortgage deals available for first-time buyers, but some of the best deals include:
In addition to the cost of the mortgage, there are a number of other costs associated with buying a home, including:
