How is Mortgage Affordability Calculated?

Calculating the amount you are able to borrow is an essential part of the mortgage process. To some, it may seem like someone is putting up barriers, or passing judgement.

Don’t take it personally. Going over your finances is a sensible, practical, and essential, step to take when looking at what you can afford to pay each month for your mortgage. It’s something that is done as much to protect yourself as much as the lender, especially if you are talking about a 25-year commitment.

Making Sure Your Home and Comfort is Not at Risk

In the past, lenders would assess the amount of a mortgage based on a multiple of your income. This varied from lender to lender, and might have been anything between three times and five times your annual income (or more in some cases), depending on when, where and what you were buying.

As a direct result of the financial crisis in 2007-08 a lengthy review of the mortgage market was carried out by the Financial Conduct Authority. This review brought in new guidelines in 2014 to prevent irresponsible lending. Mortgage lenders need to assess the level on monthly payments you can afford, accounting for all your expenses. This is called an Affordability Assessment.

“How much can I borrow?” is a common question that lenders hear from people looking to buy a new home. There are many mortgage calculators online (ours included) that act like a mini affordability assessment, and will give you a good guide of what you could borrow.

Some lenders may take into account the size of a deposit you can put down, the planned duration of the loan, whether it’s for a second property and where the property actually is. But in general, all lenders are mainly concerned with two factors: your income and your outgoings.

Your Income

How much money are you earning or receiving each year? The assessment will take a look at:

• Annual salary and monthly take-home pay
• Any benefits you receive
• Any second jobs or part-time work income
• Any declared property income

If you are applying for the mortgage in combination with your partner, spouse, relative or a good friend, then they will want to check their income too.

You will probably have to show documentation for all the above and should be prepared with payslips, a P60 form, bank statements, etc.

What if you are self-employed? Obviously, this makes things a little more difficult, but not insurmountable. In the absence of payslips and a P60, you will need to provide three years’ worth of tax returns and a copy of your accounts certified by a chartered accountant. You may also need to show evidence of upcoming work booked in over the upcoming months, and a business plan.

Your Outgoings

The assessment will also look at your regular and anticipated outgoings over the course of the year, to see how much you can budget for mortgage payments. This can include:

• Bills – water, electricity, gas, broadband, council tax, phone, etc.
• Childcare costs and/or maintenance
• Travel costs – to and from places of work, and vehicle maintenance
• Debts – credit cards, loans repayments or another mortgage
• Groceries
• Insurances – personal, life, buildings and contents
• Leisure – going out, entertainment, sports & hobbies
• Holidays
• Rent – although this will change if you get a mortgage, it is a useful guide as to what you have been used to budgeting

Once you have generated figures for all the above, you and the lender will then have a clear picture of what you can afford to pay each month for your mortgage over a certain duration and see how much money you will be able to borrow.

Stress Tests

As well as assessing your income and outgoings, a lender will want to gauge how your finances might cope with a sudden change. Would you still be able to keep up with the mortgage payments if any of the following happened?

• The interest rate increased suddenly, giving you larger monthly payments
• You or your partner lost a job
• You are prevented from working due to illness
• Your life changes due to having a baby, or taking a career break

Any of these occurances could have an impact on your ability to repay your mortgage, and all of them at the same time could be catastrophic. However, we know that life is never one simple path, and the emphasis is often on making a good plan.

The Key to a Solid Mortgage

The most important thing you can do is to think ahead. Make a plan of what you intend to do over the coming years and get a solid picture of where you would expect your finances to be in all this. Perhaps you could build up your savings so you would be able to run your household for three months if something unforeseen did occur. Or also consider over-paying on the mortgage when you can, so your debt comes down sooner.

A mortgage is a big commitment and the whole process will go much more smoothly when you know where you are going.