Historically lenders looked at something called income multiples. This is where they take your annual salary and multiply it by a pre-determined number. Around four times was the general rule of thumb. So in simple terms if you earn £25,000 then you can borrow four times that so £100,000.
Mortgage Lenders, Income Multiples And Affordability
These days though lenders are using a term called “affordability”, but still in the background (although they may not tell you) they continue to use income multiples.
So what do you need to consider if you are on the hunt for a mortgage and don’t know how much you can get?
Loans, Hire Purchase, PCP (car finance)?
All of these will be taken into consideration by lenders when they work out how much they will lend. If the agreement has less than six months to run then most lenders will ignore it (but not all).
How does it affect you?
As a rule of thumb the lender will take the monthly payment and multiply it by 12 (to get the annual amount) and then apply the multiplier noted above and remove this figure from the maximum amount they will lend. So for example if your car finance costs you £200 a month, this is £2400 per year so multiply that by four and that will mean you can borrow £9600 less than you would be able to do had you not got the loan. However as lenders are not explicit about the income multiples used as they use affordability calculators the above example will be different for each lender.
You have to be careful here as many people use credit cards regularly and clear the balance each month when the bill arrives. This is great for air miles (other loyalty programmes are available) and the like. It is also good for your credit rating to be seen as using a credit card sensibly and clearing the balance each month. Lenders have different views on credit cards so they will likely take one of two approaches.
- If you have an outstanding balance that is carried over each month then the lender will typically take 3% of the balance and treat that as a monthly commitment in the same way as a loan above.
- If you do clear the balance each month, or plan to clear the balance before the new mortgage completes, then generally it will be ignored as a commitment.
There are a couple of exceptions with the odd lender in that even if you clear the balance they will treat it as a commitment, they do this by taking the most recent balance they can find when they do the credit scoring (which could be the balance from 2 months ago) then apply the 3% rule above. This will have the effect of reducing your borrowing capacity.
Childcare. School Fees, Maintenance Payments?
If you are paying any of these they will be treated as a regular commitment and the lender will take it into account as with the commitments above.
If you are receiving maintenance payments this could be classed as income; it needs to be legally binding under a court order and you will need to show a track record on your bank statements, ideally six months worth.
Or dependents. We know they cost. All lenders now ask if you have dependents and they apply statistical analysis behind the scenes to calculate the effect on your ability to pay a mortgage. In reality they may use a version of the multiplier described above and thus reduce the amount you are able to borrow.
Other Regular Outgoings?
Where does it stop I hear you say? Well I did hear reports that lenders were scrutinising bank statements so closely that things like Gym membership subscriptions were being taken into consideration. I have not come across this personally but here is a list of things that could be taken into account:
- Service Charges/Maintenance on Flats,
- Ground Rent,
- Pension Contributions,
- Some deductions from payslips e.g. season ticket loans, share save, private medical cover.
The list above is not exhaustive but what I have found in the past few months is that lenders are trying to take a bit more of a common sense approach with regard to some commitments. For example you can stop the share save scheme at work if things get a bit tight so this might get ignored.
I’m afraid it is a bit of a minefield but most lenders do have affordability calculators on their websites so if you answer those honestly then you will get an idea of what you can borrow. My method comes from experience so I will chat to the client, ask relevant questions and then decide which mortgage lender to approach after that.