Table of Contents
- What is Mortgage Affordability?
- What is the Affordability Test for a Mortgage?
- What to Consider When Preparing for a Mortgage Application
Exploring the changing UK housing market is essential for potential homeowners in 2024, especially regarding mortgage affordability checks. These checks ensure borrowers can comfortably handle their repayments under various economic conditions. Let’s delve into mortgage affordability checks, with a focus on the process of stress testing.
What is Mortgage Affordability?
Mortgage affordability is about more than just being able to send in your monthly payment; it’s about being able to do so comfortably, without compromising other financial obligations or your quality of life. Banks and building societies conduct thorough checks to ensure that after all your expenses, you have sufficient funds left each month. This buffer helps you manage unexpected costs without jeopardising your mortgage payments.
These types of checks are important because with mortgage rates increasing banks want to ensure you are able to afford the monthly payments. If you fall behind your monthly mortgage payments, this could have great impact on your credit report. Which, could in turn affect you trying to get a mortgage, loan or even a phone contract in the future. Although, banks provide certain help with your payment such as; mortgage payment holidays, your home could be repossessed.
Repossession may sound scary, however this is a rare occurrence. Banks and building society work on a worse case scenario, where they will not lend unless they know you can afford it. Furthermore, Banks and building societies are also under the rules of the Financial Conduct Authority, meaning you’re protected from taking out too much mortgage finance. The mortgage affordability test also acts as a pre-vetting before you are signed off on a mortgage.
What is the Affordability Test for a Mortgage?
Mortgage affordability tests are crucial tools used by lenders to determine how much you can borrow. The test is there to help you as well as the Banks or Building societies understand how much they can lead to you. As well as checking if your mortgage application will be accepted. They involve several key checks:
Income Multiples
Lenders start by applying ‘income multiples’ to your salary to gauge the maximum loan you might be eligible for. For instance, a lender may use 3.5x times your annual income. If you earn £30,000, this would potentially allow you a mortgage up to £105,000. However, if you’re buying with someone else you can add your incomes together and then apply the lender’s multiplier.
For first-time buyers however, the lender’s multiplier, could see you getting 4.5x times your annual income. For example, a single person earning £30,000, would potentially allow them to get a mortgage up to £135,000. But if they are purchasing with someone else and they also earn £30,000, with a combined annual income of £60,000, the duo could borrow up to £270,000.
In some cases high street lenders could agree to a 5.5x times a borrower’s salary, with the assurance from the borrower providing a higher deposit of 15% to 25% and also earn at least £75,000. For first-time buyers to be eligible for this they will need to earn £37,000 or more and require 5% deposit with an excellent credit history.
Assessment of Income and Outgoings
Once the lender has determined the maximum amount you can borrow, they will then assess whether you can manage the monthly mortgage payments with your post-tax income. This evaluation occurs after accounting for all your other bills and everyday living expenses.
Accepted Incomes:
- Basic employed and self-employed earnings
- Benefits such as child and working tax credit
- Pension Income
- Rent from a buy to let property
When calculating your outgoings, be sure to include all your regular expenses such as council tax, utilities, and phone contracts, along with any monthly debt repayments. Don’t forget to factor in transportation costs, childcare, school fees, grocery shopping, and spending on social activities, holidays, and hobbies.
After deducting all your expenses from your income, it’s important to have sufficient funds remaining to cover your mortgage payment, plus a little extra. This buffer ensures that you can continue to make your payments comfortably, even if interest rates increase.
The Importance of Stress Testing
A mortgage lender’s stress test is designed to evaluate whether you can still afford your mortgage payments if interest rates were to increase by 3%. After completing your assessment of income and expenditures, the remaining funds should be adequate to cover a mortgage payment at an interest rate that’s 3% above your lender’s standard variable rate (SVR).
Currently, the average SVR is around 8.18%, which means you would need to be prepared for a potential rate of 11.41% to pass this test. While this may seem high, it ensures you have a cushion in your budget in case of future rate increases. An effective way to mitigate the impact of this stress test is to choose a five-year fixed-rate mortgage. Many lenders relax the stress testing requirements for longer-term fixed rates, reducing financial risk for borrowers.
Debt vs. Income
You’ve received your maximum mortgage offer and determined that, after covering your bills and expenses, you still have enough money left over to handle a mortgage rate of more than 11%. Now, there’s just one more challenge to navigate: maintaining a low Debt to Income (DTI) ratio.
Calculating your DTI ratio is straightforward. Simply take your total credit card debt, divide it by your annual salary, and then multiply by 100.
But what does this number represent? Generally, to be considered by most lenders, your DTI should be 30% or lower. If your DTI reaches up to 40%, you might not qualify for the highest income multipliers. A DTI of 50% or higher categorises you as a high-risk borrower, limiting your options to a few lenders who may only offer mortgages at higher interest rates and demand an excellent credit score and history.
Lenders will also consider the amount of your monthly debt repayments when performing their affordability checks.
What to Consider When Preparing for a Mortgage Application
Understanding how lenders assess affordability can significantly enhance your chances of obtaining a mortgage. Be mindful of your debt levels, keep your financial records organised, and consider how future interest rate changes might affect your repayments. Preparation and knowledge are your best tools for navigating the mortgage application process successfully.
By understanding these elements of mortgage affordability, you’re better equipped to find a mortgage that suits your financial situation and to approach the application process with confidence. Remember, the goal is not just to get a mortgage but to maintain it comfortably over the long term.
