Understanding mortgage affordability entails the ability to smoothly manage monthly mortgage repayments. Dive deeper into comprehending the mechanics behind affordability and discover the intricate ways lenders employ mortgage affordability tests to ascertain your borrowing potential.
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Before your bank extends thousands of pounds to facilitate your entry onto the property ladder, you must demonstrate your capability to repay the loan.
Your monthly mortgage payments are expected to constitute your most significant financial commitment, bearing the most severe repercussions should you happen to lag behind on repayments.
Hence, banks and building societies meticulously assess your mortgage affordability, requesting evidence of your income and expenses when you seek a mortgage.
What is mortgage affordability?
Mortgage affordability signifies the capacity to effortlessly manage your monthly mortgage repayments, in addition to existing debts, household expenses, and living costs. This denotes that your home loan remains within affordable bounds.
The pivotal aspect is to ensure comfort. Once all your expenses are tallied up and deducted from your earnings, it’s essential to have surplus cash remaining as a cushion for unforeseen bills that may arise.
Mortgage affordability holds significant importance for two key reasons. Firstly, any delay or default in mortgage payments gets documented on your credit report, remaining there for six years. This can substantially lower your credit score, impacting your prospects of securing future mortgages, loans, or even mobile phone contracts. Secondly, failure to meet the minimum contractual payment or abide by arrangements made by your lender could lead to repossession of your home, which would be sold to settle the outstanding debt.
While it may sound daunting, repossession is actually a rare occurrence. Banks and building societies are obligated to lend responsibly according to regulations set by the Financial Conduct Authority. This safeguards borrowers from acquiring excessive mortgage finance through an affordability assessment, ensuring prudent lending practices.
What is a mortgage affordability test?
Mortgage lenders employ a mortgage affordability test to ascertain the amount you can comfortably borrow for a mortgage. This assessment determines both the lending limit and the feasibility of approving your mortgage application.
A mortgage affordability test involves a couple of checks, these include:
Income multiples
To calculate the maximum mortgage a lender might extend to you, banks and building societies utilise a method known as income multiples.
Suppose your annual pre-tax income is £30,000. Using an income multiple of 3.5, a lender would multiply your £30,000 salary by 3.5, resulting in £105,000. If purchasing jointly with another person, combine both salaries and then apply the lender’s specified multiplier.
For first-time buyers, a prevalent income multiplier is 4.5 times the earnings. Thus, an individual earning £30,000 annually could potentially receive a maximum mortgage offer of £135,000, whereas a couple with a combined income of £60,000 might be eligible for a mortgage offer of £270,000.
The majority of high street lenders are willing to approve a mortgage that amounts to 5.5 times a borrower’s salary, provided they possess a deposit ranging from 15% to 25% and earn a minimum of £75,000. However, with a 5.5x Income Mortgage, first-time buyers earning £37,000 or more only need a 5% deposit and a stellar credit history to qualify for a mortgage that’s 5.5 times their salary.
Individuals employed in professional roles such as accountants, solicitors, or essential roles like NHS, blue light, or key worker jobs are eligible to apply for Professional Mortgages. These mortgages enable borrowers to potentially borrow 5.5 or even 6.5 times their income.
You can increase your mortgage size through family support. Various ways exist for your loved ones to aid your purchase without necessarily needing cash on hand. Explore the array of guarantor mortgages we recommend to discover more about this option.
Income and outgoings assessment
After determining the maximum value of your mortgage, the lender will verify your ability to comfortably make payments from your monthly post-tax earnings, considering all other expenses and deducting daily living costs.
Generally accepted types of income encompass:
- Basic employed and self-employed earnings
- Benefits such as child and working tax credit
- Pension income
- Rental income from a buy-to-let property
When calculating your expenditures, ensure to encompass: all recurring bills like council tax, utilities, and phone contracts; monthly debt repayments; transportation expenses; childcare and school fees; costs related to food shopping; as well as expenditure on social activities, holidays,
After deducting all your expenditures from your income, it’s essential to have a surplus amount to cover your mortgage payments along with an additional buffer. This precaution is to guarantee that you can manage repayments even in scenarios where interest rates increase.
Stress testing
A mortgage lender’s stress test isn’t about assessing your ability to handle pressure. Rather, it determines whether you could manage your mortgage repayments if interest rates increased by 3%. After evaluating your income and expenses, the remaining surplus should suffice to cover a mortgage with an interest rate 3% higher than your lender’s standard variable rate (SVR).
The current average standard variable rate stands at 8.19%, indicating the necessity to demonstrate an ability to manage an interest rate of 11.41% for approval. While this might seem high, it allows ample room in your budget for potential future interest rate hikes. Opting for a five-year fixed rate is a way to bypass the stringent stress test. Certain lenders don’t subject borrowers to such a high stress level if they opt for a fixed rate for five years or longer, as it’s perceived to mitigate risks for the borrower.
Debt versus income
Alright, you’ve secured your maximum mortgage offer and confirmed that you possess enough surplus funds after covering bills and expenses to handle a rate exceeding 11%. Now, there’s just one more obstacle to overcome – achieving a low Debt to Income ratio.
Calculating your Debt to Income (DTI) ratio is straightforward. Simply divide the total debt accumulated on credit cards by your annual salary, and then multiply the result by 100.
To elucidate, here’s what it signifies: For widespread acceptance by nearly all lenders, aiming for a DTI of 30% or lower is advisable. If your DTI reaches up to 40%, you might not be presented with the highest income multipliers accessible. However, if your DTI reaches 50% or higher, lenders view you as a high-risk borrower. Consequently, your options for mortgage deals may be restricted to a few lenders offering higher interest rates, and maintaining an impeccable credit score and history becomes crucial in this scenario.
Lenders will also take into account the level of monthly debt payments as part of their affordability checks
Boost your buying budget
If you’re facing challenges with your mortgage affordability and need a larger mortgage, consider reaching out to Tembo. We specialize in assisting buyers, movers, and remortgagers in enhancing their mortgage affordability via a variety of specialized schemes. On average, our customers increase their purchasing budget by £82,000!
- What About Bonus Or Overtime?
While you can augment your earnings through bonus pay, overtime, and commission, lenders often limit the amount you can utilise from these sources as they can fluctuate.
What factors determine mortgage affordability?
Mortgage affordability is determined by various factors, including your income, regular expenses, credit history, and outstanding debts. Lenders assess these aspects to gauge your ability to manage mortgage repayments.
How is affordability calculated for a mortgage?
Lenders typically calculate affordability using the "income multiple" method or the "affordability assessment." The income multiple involves multiplying your gross annual income by a certain factor (usually 4-5 times) to determine the maximum loan amount. Meanwhile, affordability assessments consider your income, expenses, debts, and financial commitments to ascertain what you can afford to borrow responsibly.
What role does the deposit play in mortgage affordability?
The deposit you put towards a property significantly impacts mortgage affordability. A larger deposit means borrowing a smaller amount, potentially securing better interest rates and monthly repayments. Lenders often require a minimum deposit percentage, usually around 5-20% of the property's purchase price.
How can I improve my mortgage affordability?
Improving mortgage affordability involves several steps. Firstly, reducing outstanding debts and maintaining a good credit score can positively influence lenders' assessments. Increasing your income or combining it with a partner's income may also enhance affordability. Additionally, considering more affordable properties or saving for a larger deposit can expand your options and improve affordability.
Conclusion
Understanding mortgage affordability is crucial when navigating the process of buying a property, ensuring that you make informed decisions aligned with your financial capabilities and goals.
