Understanding Mortgage Affordability in the UK
Owning a home is a dream many aspire to. To bring this dream to fruition, most individuals turn to banks and building societies to secure a mortgage. But how do these lenders decide how much you can borrow? The simple answer is by assessing your ‘mortgage affordability’. This blog will delve into the intricate world of mortgage affordability, explaining its core concepts and how lenders in the UK evaluate it.
What is Mortgage Affordability?
Mortgage affordability refers to a borrower’s capacity to meet monthly repayments on a mortgage without stretching their finances too thin. It’s a measure that ensures borrowers don’t overcommit themselves financially and that lenders don’t lend money to individuals who might struggle to pay it back. This is not only in the lender’s best interest but also protects borrowers from finding themselves in unsustainable debt situations. How much you can borrow is far more complicated than most people realise, and the difference between lenders is often surprising. This is why it’s so important to establish exactly what your maximum budget is before you start looking at properties.
Factors Influencing Mortgage Affordability
While you might think it’s as simple as examining a borrower’s income and expenses, lenders in the UK actually adopt a holistic approach, considering various factors:
1. **Income:** Your salary (either from employment or self-employment) forms the foundation of your affordability. This includes regular bonuses, overtime, and commission. Lenders might also consider additional income sources like rental income, some state benefits such as child benefit, universal credit and disability living allowance. Each lender decides what income they will use, which is why mortgage affordability varies from lender to lender.
2. **Outgoings:** Lenders look at your regular expenses. This includes your current financial commitments like credit card bills, loans, or childcare costs and everyday living costs such as groceries, utilities, entertainment, and travel. They also factor in your household make-up, for example, the amount a couple with no debts or children will normally be able to borrow more than a single person with two children and high credit card balances.
3. **Existing Debts:** These are debts you have with other lenders or credit providers. If you have significant outstanding loans or hefty credit card balances, this could impact the amount a lender is willing to offer.
4. **Credit Score:** This is a numerical representation of your creditworthiness based on your credit history. A high credit score signals that you’re a reliable borrower, whereas a low score might indicate potential risk.
5. **Loan-to-Value (LTV) Ratio:** LTV is the ratio between the loan amount you want to borrow and the property’s value. If you’re putting down a £20,000 deposit on a £200,000 home, you’re borrowing £180,000, and the LTV is 90%. Generally, a lower LTV (meaning a larger deposit) can improve your mortgage affordability as it reduces the lender’s risk.
6. **Stress Testing:** Lenders use hypothetical situations to test how potential future interest rate increases might impact your ability to meet repayments. They want to ensure you can still afford repayments if circumstances change.
7. **Overall Mortgage Term:** The length of your mortgage (e.g., 25 years, 30 years) can affect monthly repayments and, thus, affordability. The shorter the mortgage term, the higher the monthly mortgage payments; therefore, the more disposable income you need to be able to pay your mortgage and afford to live a good standard of living. The longer the mortgage term, the lower the payments, which may mean you can borrow more. However, bear in mind that you will pay more interest over the term the longer it is.
8. **Future Changes:** Lenders might also consider foreseeable changes to your circumstances – such as imminent retirement, a planned career break, or maternity leave. This doesn’t mean you can’t get a mortgage; it means we need to know what your future plans are if you know they’re going to be changing so that you don’t borrow more than you can afford.
How is Mortgage Affordability Calculated?
Traditionally, lenders used a basic income multiple to determine how much they’d lend. For instance, if a lender offered a multiple of 4 and you earned £25,000 annually, you could potentially borrow £100,000.
However, post the financial crisis and under the guidance of the Financial Conduct Authority (FCA), the assessment of mortgage affordability in the UK has become more refined. The focus shifted from income multiples to a more comprehensive affordability assessment.
Today, lenders use complex models to weigh the factors mentioned earlier. They examine bank statements, payslips, and other documentation to get a detailed picture of your finances. While the specific calculations vary among lenders, the principle remains consistent: can the borrower comfortably repay this mortgage now and in the foreseeable future?
Tips to Improve Mortgage Affordability
If you’re looking to maximise the amount you can borrow, consider the following:
– **Boost Your Credit Score:** Regularly check your credit report, ensure all details are correct, pay your bills on time, and avoid maxing out credit cards.
– **Reduce Debts:** Try to clear as much outstanding debt as possible before applying for a mortgage.
– **Save a Larger Deposit:** A bigger deposit can potentially secure you a better mortgage deal and improve your LTV ratio.
– **Limit Outgoings:** Before applying for a mortgage, try to reduce unnecessary outgoings to demonstrate fiscal responsibility.
Mortgage affordability is crucial for both lenders and borrowers in the UK. It ensures that borrowers take on mortgages they can manage and that lenders provide funds responsibly. By understanding how this process works, you’re better equipped to prepare for your mortgage application and take a significant step towards homeownership. Remember, always seek advice from a mortgage adviser or broker to understand your unique situation.
