How much can you borrow for a mortgage? A guide to borrowing and affordability
Having done this job for nearly 20 years, the most common question I have been asked by clients is – How much can I borrow and how much is it going to cost?
The ‘cost’ question is down to product choice, which I will deal with in a later blog, but the ‘how much’ is something I will tackle here. As this will be a beast of a blog, given it is the largest and most complex topic in all of lending, I’d suggest you do the classic ‘ctrl+f’ to search for the section that applies to you, or if you fancy some advanced mortgage reading, enjoy!
According to the FCA, since 2007, a staggering 340 regulated mortgage lenders have had to file quarterly returns to them! If you are asking yourself – why are there so many lenders, read on…
As a rule of thumb, life just seems to get more complicated as time rolls on. Nothing is truer of that than how people get paid. According to the ONS (Office for National Statistics), around 15% of the UK workforce are classified as Self Employed, with that number growing (which is around 4.8 million people). With an increasing trend of younger people being their own boss sooner (16-24-year olds specifically, have seen a 74% increase since 2001) either a Sole Trader, Limited Company, Partnership, or even a combination of these. This makes assessment of self-employed income more complex, but that is not to say it is a bad thing, as I will explain.
Therefore, you could deduce that for the remaining 85% it is simple. Sadly not… In a very competitive workplace, employers are keen to tie in staff with incentives, bonuses, commission, vesting stock options, Profit Share schemes or even equity. Below I have broken down the most common things we have seen, how lenders approach them, so you can show off in the bar to your friends and work out (roughly) how much they could borrow. Simples eh?
Firstly, some context on how lenders lend. Back in October 2014, the Bank of England chose to impose a cap on lenders – not more than 15% of their new lending could be above 4.5 x income. At the time, they felt the market was overheating and they wanted to flex their muscles following the credit crunch fall out and subsequent powers they obtained. So, for the shortest possible answer to the question, how much can you borrow – the answer is, about 4.5 x your income. As you will see below, how you define that income is not at all straightforward, and don’t assume banks will include all your income. While the 4.5x income rule fits for 85% of people, there is relative free reign on the other 15%, so some lenders go as far as 6 x income and some lenders will also take up to 4 incomes into account on one application. At that end, the numbers start to get punchy… So how is your income defined by lenders:
If you are Employed, below are the most common ways you will receive your income, and the most common ways lenders calculate what they will use in their assessment, but as noted, there are huge variances in this.
Salary – lenders will take 100% of your gross salary. However, some lenders will deduct things like pension payments, student loans or childcare costs, so be mindful to work on the post deduction income
Bonus – most lenders will typically take 50% of any annual bonuses, if there is a 2-year track record, with a few taking a larger % up to 100%. If any bonuses are paid more regularly such as monthly or quarterly, some lenders will include 100% of this income. As a rule though, lenders will take 50% of any variable, non-guaranteed income
Commission – pretty much as above for bonuses
Stock options/vesting stock schedule – Typically these aren’t classified as income by most lenders (even though in the real world they very much are). That said, some lenders will include this either as income (most typically Private Banks, or lenders that understand Higher Earners income) or towards the repayment strategy of an Interest Only loan
Zero hours contracts – Most lenders will require 12 months minimum track record and use the total income in the assessment, or P60, whichever is easier to evidence income, then treated as a salary
Example – below is a simple, real world example, of how lenders treat the above and the wild variances that then creates in how much you can borrow:
Client A earns a basic salary of £50,000 and quarterly bonuses that equate to another £50,000pa
Lender A offers the standard assessment and therefore a loan of £337,500 (100% of basic, plus 50% of bonus x 4.5 = £337,500
Lender B offers to take 100% of the bonuses and at a higher multiple of 5.5x income, and therefore will offer a loan of £550,000
Both the above are standard criteria of high street lenders, proving that if you don’t shop around, you could be offered a staggering £212,500 (or 63%) LESS from different lenders. That can make a huge difference if you were house hunting or looking to raise money for whatever reason. The actual amount offered may vary depending on your deposit level and credit profile, as described in the sections below. Also, don’t assume just as you borrow more, the rate is higher, often the converse is true. The rate is determined by the lender, then their criteria is applied, not the other way around.
If you are Self Employed, it is more complex (and bear in mind, most lenders will classify you as self employed if you own 25% or more of the shares in a company). Ideally, you’ll have a two year + trading record, but some lenders will work on just one year. With less than a year trading it is generally not possible to get a mortgage unless you have moved into Contracting, so see below if that is you. The easiest way to describe it is that lenders will include, one, some or all the following forms of income:
- Dividends (some lenders even ‘gross up’ the Dividend, which really boosts what you can borrow)
- Net profit (or Profit on ordinary activities before tax for a Ltd Co)
- Drawings (if an LLP)
The general rule is that the income over the last two years is averaged, assuming income is stable or on an upward trend. If there is a downward trend, questions will be asked, but if there is a good reason, it will be the most recent year, not the average that is taken. Conversely, on a healthy upward trend, some lenders will just take the most recent (higher) figure. As a rule, retained profits can’t be used, but that does show in the ‘Profit on ordinary activity before tax’ section of the accounts, so I would recommend if that applies to you, you’d use a lender that looks at that. Some payments like pensions can be added back in as well. If there has been a loss in the last two years, most lenders will flat decline the application, but some more pragmatic lenders can take a view if there is a good reason. Confused yet…
So again, giving a simple example:
A client has a Ltd Co which has been trading for three years, for argument sake, the averages come out at:
Salary = £12,500
Dividends = £87,500
Net Profit = £87,500
Profit on ordinary activities before tax = £100,000 (or POOABT)
Lender A just looks at Net profit, and offers a 4.5 x multiple, there a loan of £393,750 is offered
Lender B just looks at POOABT and applies at 5 x multiple offers £500,000
Lender C looks at salary and dividends (and ‘grosses up the Dividend) offers £550,000.
This is by no means exhaustive, but just hopefully illustrates again, the huge variances offered to the same client. Also the assessment is key, you can look at – SA302’s, Accountants reference or Accounts – so finding the simplest assessment method is also part of the puzzle as that needs to be overlaid with the lenders criteria to ensure you get the right outcome (I didn’t say it was simple).
If you are a Contractor this is a middle ground between being employed and self-employed. From a tax point of view, you will typically be self-employed and may have even set yourself up as a Ltd Co, however, many lenders treat you as a pseudo employee. Ideally there would be a 12-month track record, and a history of 3, 6, 9, or 12-month contracts under your belt. But in some instances, lenders will take your very first contract if it is in the same line of work and you have a strong CV/Day rate. A typical assessment of a contactor would be:
- Day rate x 5 x 46
The x 5, gives us a weekly figure (or however many days a week worked), then a 46-week year is used to allow for gaps in contracts. Again, the figures would break down as:
A six-month contract, on a day rate of £450 would mean you are typically offered a loan of £465,750 (450 x 5 (days) x 46 (weeks) x 4.5 (multiple applied). Most lenders will go to 5 x income on these cases so getting a loan of £517,500 on that example would not be too hard. However, if the lender does not understand contracting (which is most lenders), they will treat you as self-employed. As an example, lets say you run that contract through a Ltd Co (which is the sensible thing to do), your net profit may only show circa £50,000 once you have allowed for costs. In that instance, a lender may only offer a loan of £225,000 (50k x 4.5), which is less than half of what you can get elsewhere! So the key is – work with a lender that understands contractors and does not asses you as being self-employed.
If you have both self-employed and employed income (which we are seeing a lot more of), more and more lenders are getting in tune with this and will apply the relevant assessments above for the differing ways in which you get paid.
Deductions – Taking all the above into account, lenders do not blindly offer loans without looking at your wider situation. Therefore, any outgoings that will remain post completion will be considered BEFORE the above multiples/assessments are applied. In the simplest terms:
- Credit card balances are deducted at 5% of the balance x 12
- A card of £10,000 would equal a £6,000 deduction from your income (£500 x 12)
- Loans, HP agreements, Interest Free loans (life DFS etc), are taken at the monthly payment x 12
- A loan of £200 a month would be a £2,400 deduction from your income £200 x 12)
- Childcare costs like Nannies, Nursey Fees or Private School fees are treated as loans as above
- Not all lenders make this deduction, but the majority do.
Hence, the true picture of what you can borrow, minus the deductions above from your income as relevant above. Then apply the correct assessment and income multiple and that is what you can borrow. Simple isn’t it…
What about passive income such as?
- Rental Income
As a rule, most lenders discount this income apart from Pensions, see Employed salary above as it works the same. That is not to say all lenders won’t include it, but it is not common.
Now you can see why there are 340 lenders to choose from! There is always a lender for you, but as ever, getting the right advice, at the right time is key. A good broker will know how to navigate this very complex web as we have several tools at our disposal combined with our own experience which really is the difference in getting a case presented correctly, with the right lender, to get the right outcome.