Quick Guide: Mortgage Affordability
What do lenders consider when assessing affordability?
There used to be a time when working out how much you could borrow was a lot simpler. You’d multiply your annual income by some factor and that would be that. The factor was, and still is, referred to as an income multiple. They still exist and are still used, but are now only one aspect of an affordability assessment. An income multiple is typically used in the assessment to provide an upper limit on how much you can borrow.
Say for example you earn £25,000 and a lender uses an income multiple of 4.5 in their affordability assessment, then the maximum they will lend you is £112,500 (25000*4.5). That’s not the end of it though, affordability assessments will take account of lots of other things too.
When we’re talking commitments for mortgage purposes, we usually mean payments you have a contractual obligation to pay at regular intervals. This would include personal loans, student loans, hire purchase agreements, buy now pay later deals, personal contract plans (PCPs) and lease agreements amongst other things. These examples would all typically have a fixed monthly or quarterly payment that you must make. In an affordability assessment the total monthly cost of all of these would be taken into account and the higher these costs, the less you can borrow compared to the upper limit referred to above.
Commitments also includes credit and store card balances that are not paid off in full each month. As these often have varying monthly payments depending on the outstanding balance, lenders take a slightly different approach. They will usually count a fixed 3% of the outstanding balance as a monthly payment and add this on to the figure above for other commitment types.
Some lenders will allow commitments that have less than six months left to run to be excluded from their affordability assessment. You must be able to prove the commitment will end, which can usually be demonstrated from the original credit agreement. If you can demonstrate that you will pay off any commitment before your new mortgage starts then it can also be excluded from the affordability assessment. You must be able to show where the required funds will come from.
It is worth noting that lenders are not keen on use of pay day loans and may not consider an application from you if you have needed to use these recently.
Regardless of whether a commitment can be excluded, they must all be declared during a mortgage application or even for a decision in principle. When lenders carry out searches against your credit file, they try to match what has been declared to what is on the file. Failure to declare can be an automatic decline.
Whilst strictly a commitment, any existing mortgages are usually captured separately by lender systems. This could be your current mortgage if you are doing a remortgage or moving house, or it could be mortgage you have on buy to let properties. Again, if a mortgage will be paid off before the new one starts then it will be excluded from the affordability assessment but has to be captured.
Buy to let mortgages can often be excluded as well, providing the rent from the property is considered to be sufficient to pay that mortgage after allowing for things like void periods and repairs.
This is basically anything you spend that isn’t a commitment. For mortgage purposes, we split general expenditure into two distinct categories, non-discretionary and discretionary spending.
Non-discretionary spending covers all those things you would reasonably be expected to pay for in order to live your life and earn your salary. This includes your household bills such as broadband and telephony, council tax, gas, electric, water and buildings insurance, as well as things like childcare costs, school fees and travel costs for getting to and from work.
Discretionary spending is the rest of your general expenditure: dining out, TV packages, buying clothes and furniture, going out with your mates, supermarket shopping. These are all classed as discretionary because you have more degree of control over the costs, even to the extent you could give some of them up if needed in order to fund your mortgage payments.
Lenders consider general expenditure in their affordability assessments. If you’ve ever done one yourself on their website, you might wonder how since they don’t ask for lots of these things. That’s because they use Office for National Statistics (ONS) average data. You can find out more about ONS household expenditure datasets at their website. You’ll generally find lenders ask how many applicants and children there are. They then use this information to include ONS average expenditure data for that size of family into their assessment.
Some lenders will use ONS data for non-discretionary and discretionary spending while others allow you to input your own non-discretionary spending amounts and use ONS for the discretionary parts.
One way or another, all the costs associated with being alive are factored in to determine how much you can realistically borrow.
Credit profile and score
Affordability assessments are complex. After considering all the relevant bits of income and expenditure, most also consider how well you’ve managed your finances. If you’ve ever looked at your credit file from any of three credit reference agencies, you may be surprised how much information is in it.
A credit file will contain your address history, your electoral register status at all addresses, details of any financial links you have to other people and all your financial history for the last six years. All your commitments will be shown with outstanding balances, credit limits, a month by month history showing whether or not you paid on time and whether you have any amounts overdue. There will also be details of any court judgements, debt management plans and bankruptcies registered against you.
Your credit file also shows the same detail and history for utility and telecoms accounts.
The information in your credit file is used by many lenders to contribute to a credit score. Missed payments, defaults and generally poor financial management can all lead to a lower credit score.
The way that affordability assessment and credit score link together varies from lender to lender, but they both combine somewhere as part of the lending decision process.
All lenders review your credit profile and carry out an affordability assessment, but not all of them credit score. Credit scoring is often an automated process where there is little scope to overturn a negative decision. Where there are factors that may lead to a low credit score, it is often beneficial to approach a lender that doesn’t credit score to provide a human review of the case.
The value of using a mortgage broker
A mortgage broker is familiar with all of the above and has a good knowledge of individual lenders methods. Whilst lenders never publish their full affordability assessment models, brokers have experience of what works where and can ensure the right lender is recommended without you having to aimlessly stab in the dark. Why not take advantage of this expertise from Maxwell Moore? We won’t even charge you a fee for our advice service so long as it isn’t a buy to let mortgage.