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What mortgage can I afford

Deciding on mortgage affordability

What mortgage can I afford?  This is a broad question in that there are two aspects of mortgage affordability in the current market.

1. When considering your own budget,  what mortgage payment would you be comfortable managing?

2. What does a prospective mortgage lender consider to be the maximum mortgage payment you can afford?

These two figures are arrived at in different ways and therefore will never match.  The key limiter will be the decision from the lender as to what mortgage you can afford.

How lender answers the question ‘what mortgage can I afford?’

A mortgage lender,  when dealing with the residential mortgage application,  is obliged by the regulator to take steps that the mortgage is affordable to you.  There are certain industry guidelines that limit affordability,  but the onus is on the mortgage lender to establish what mortgage you can afford.  They do this by looking at three areas.

Income multiples

In the past,  mortgage affordability was simply calculated through a multiple of the applicant’s income.  For example,  a borrower on a £30,000 gross income applying to a lender with a four times multiple had maximum lending of 4 X £30,000 = £120,000.

Income multiples are still used by lenders as a limit on total mortgage affordability,  but are not the final answer in themselves.  All lenders will have an income multiple that they will not exceed,  but the affordability calculation goes way beyond that.

A typical income multiple in today’s market would be 4.5 X single income,  or 4 X joint income.  Although it is technically possible to arrange a mortgage as high as 5.5 X income,  this this is extremely rare.

Affordability calculations

A good way to get a ballpark answer to the question ‘what mortgage can I afford?’,  is to use an affordability calculator which many lenders have available to the public online.  A mortgage affordability calculator,  however,  is best used by an independent mortgage broker for reasons set out below.

Affordability calculators take into account both incomings and outgoings before a number of behind the scenes calculations leads to a maximum affordability figure.

Many items can affect affordability within a mortgage calculator,  not only obvious items such as current debts and number of dependents,  but also factors such as mortgage term,  and employment status.

Are lenders mortgage affordability calculators accurate?

The simple answer is yes.  Generally the mortgage affordability calculator that the mortgage lender place on their website is a direct copy of the one they use in-house.  The complication is that,  in order for the calculator to work correctly ,  the requested information has to be keyed in correctly.

The borrower who is unfamiliar with the lenders mortgage affordability calculator is unlikely to correctly identify what mortgage they can afford.  All lenders have a number of different boxes for data entry and each will have a specific box for particular items like bonus,  commission,  overtime.

There are further complications – for example a lender will generally treat a bonus paid annually very differently from one paid monthly or quarterly.  Therefore, bonus needs to be keyed into the affordability calculator in the right way.

Various items can be considered or discounted by lenders in affordability calculators,  examples are:

  • student loans
  • pension contributions
  • tax credits
  • irregular bonuses
  • car allowances

Mortgage affordability stress testing

Even though your income and outgoings may suggest affordability for a mortgage today,  lenders are required by the regulator to apply a further stress test to your maximum affordability calculation.

A stress test considers what would happen if mortgage rates were to increase in the early years of your mortgage and whether increased payments would be manageable.

A mortgage that may otherwise be affordable,  can sometimes be capped by the stress testing element.

Tip – often selecting a five-year fixed rate can remove an affordability limitation through stress testing.

Mortgage quote

Once you have worked out what mortgage you can afford, you will be considering your mortgage lending options and the products available to you.   As part of that process,  your broker or your lender will provide you with a mortgage quote.  This is currently known as a Key Features Illustration or KFI.  Due to the Mortgage Credit Directive,  the standard format will be reverting to the European Standardised Information sheet (ESIS) between 2016 and 2018.

Video – mortgage quotes explanation

The idea behind a mortgage quote (KFI or ESIS) document is to standardise the data provided and the format in which it is produced,  to allow the borrower to accurately compare products.

The mortgage quote is only a requirement for a regulated mortgage product,  for example for a residential purchase.  Mortgage quotes,  although not a legal requirement in a buy to let mortgage transaction,  are still normally provided and follow the same KFI format.

Your mortgage offer,  when it arrives,  will mirror your mortgage quote and be set out in the same way.

The law requires your broker or lender to provide you with a full mortgage quote for your intended product before application.  Where there is a change during the application process,  for example a reduced purchase price or a change in lending requirement,  a new mortgage quote or KFI (ESIS) will be produced.