For those not in the know, “Mortgage Affordability” checks determine how much you can borrow in certain situations. I won’t bore you with the full details now but at a high level, most mortgage lenders ignore the monthly payments you will make on the mortgage, and apply a ‘stress rate’ which is generally a higher interest rate to see how you may cope in the future when rates rise or your income decreases.
Last week, Nationwide, who are typically more of a conservative lender have branched out and are offering First Time Buyers mortgages of up to 5.5 x their income. While this is a limited offering for just First Time Buyers who specifically take out a 5 or 10 year fixed rate, up to a maximum of 90% of the property value, this is still quite a departure for them. This is also part of a larger trend we have seen since the easing of lockdown.
It is crucial to note that the annual costs of any outstanding commitments such as debts, or childcare costs/school fees are deducted from your income BEFORE the below metrics are applied (so in a simple example, if your nursery fees are £1,000 a month, £12,000 is taken off your income before the multiple is applied. The same with Loans/Credit Cards etc). This approach favours higher earners, so we’ll look into that in a bit more detail now depending on your situation.
Mortgage affordability checks if you are Employed
Generally speaking, if you earn, or have a combined income of £75k + a lot of the large lenders will offer you 5.5 x your income. You generally need a 15% deposit or more. Variable income such as bonuses/commission is dealt with differently though.
- The Majority of lenders only take account of half of your variable income, but some do take all of it. So, in a simple example, if you had a basic salary of £100k, and a bonus of £100k:
- Lender A offers you a loan of £825k (as they take half your bonus).
- Lender B offers you a loan of £1.1m (as they take all of your bonus).
- So, as you can see, a significant difference, especially if you factor in some lenders only offer 4.5 x your income, so there is a huge range of loans offered depending on the make-up of your income and the lender you work with.
Mortgage affordability checks if you are Self Employed
This is where things get a little more complex. Generally speaking, the rules above all apply, but the key difference here is what income the lender takes. If you are self-employed, lenders may use one, or some of the below depending on how you are set up (Limited Co/LLP/Sole Trader etc.).
- Your basic salary
- Net profit
- Profit on ordinary activities before tax
It is also important to note that some lenders ‘gross up’ Dividends, which means they add the tax back in as you receive them net. Let’s use the same example as the above, but this time you have a £100k salary and a £100k dividend.
- Lender A offers you £1.21m (as they ‘gross up’ dividends).
- Lender B offers you £825k (as they only take half your dividend).
- Lender C offers you £500k (as they don’t count dividends at all)
In reality the range and complexity of the above is far greater as a number of assumptions are made (primarily that the company is profitable, as if that isn’t the case, the loan on offer will be £0), but it is a fair yardstick to start out at.
Mortgage affordability checks on Buy To Let
This is where stuff gets really funky. Unlike your personal income, it is the rental income which is the real driver here. That said, some lenders do ‘top slice’ which means if you can prove you have surplus income after clearing your liabilities each month, they ignore the rules below and can offer you the loan you need.
The logic for the approach is that lenders ignore the rate you pay, as per the above, but then lenders stress the rate again to cover things like rental voids, tax, property upkeep etc, so you effectively stress the stress rate…
- For the sake of comparison, we’ll look at what each £1,000 of rental income a month equates to as a loan. So, if you get £3k a month, times the below by 3, you get the idea:
- The ‘standard’ Buy To Let calculation means you would be offered a loan of £150,470 (this calculation assumes an interest rate of 5.5%, and a stress rate of 145%).
- Some lenders offer lower stress rates if you take a 5-year fixed rate or are doing a like-for-like refinance. In this instance, your £1,000 rental income gets you a loan of £213,333 (assumed interest rate of 4.5%, with a stress rate of 125%).
- The lowest standalone calculation at present means your rental income of £1,000 would get you a loan of £480,000 (which is an interest rate of 2%, with a stress rate of 125% – however, your income will need to be factored in to afford the loan).
As you can see, there are a huge range of outcomes here. It is actually more complex and varied than the above suggests, but again, this is to just give you an idea of how it works and what ballpark you should try and be in.
This is the most complex part of mortgage lending and where brokers earn their keep. Some tech firms are trying to model this out. The results aren’t 100% effective yet, but they are getting there. So, for now, it is understanding the dark art of what lenders to use and why, coupled with a lot of patience to research the most likely contenders…
Swap rates (which typically fund fixed rate mortgages) just edged down again last week with Libor (which typically funds variable rate mortgages) up a fraction.
So our default position stands, unless you have any specific needs, we would most likely recommend a longer term fixed rate if you have a 25% + deposit, but keep it short term or flexible if less than that figure. We are yet to see the ‘big boys’ come into the 95% Market, so once we see some movement there, we also expect the cost of mortgages at this level to start to decrease, but that may take some time yet.
In the last week:
3 Month Sterling Libor = up by 0.004% at 0.087%
2 Year SWAP = down by 0.006% at 0.271%
5 Year SWAP = down by 0.030% to 0.630%
Bank of England Base Rate = Held at 0.10%
2 Year Variable from 1.19%
2 Year Fixed Rates from 1.05%
5 Year Fixed Rates from 1.23%
BTL Rates from 1.19%
The actual rate you will be offered will be dependent on your personal circumstance and deposit level. Please speak to one of our advisers so that they can guide you through this process.
Source: Twenty7Tec April 2021
If you would like to speak to any of our team regarding your mortgage affordability checks on any mortgage goal that you have, we would be delighted to help. You can find the contact details of the team here.