The capacity to easily repay your mortgage each month is known as mortgage affordability. Learn how mortgage affordability tests are used by lenders to assess your borrowing capacity by continuing to read.
Read More: Mortgage Affordability Calculator
You must demonstrate your ability to repay the thousands of pounds your bank has given you before they will allow you to purchase real estate. Your mortgage is probably the largest expense you have on a monthly basis, and it also has the most serious repercussions if you fall behind on payments. Consequently, when you apply for a mortgage, banks and building societies thoroughly examine your application for mortgage affordability and require documentation of your income and expenses.
Mortgage affordability: what is it?
The capacity to comfortably pay down your mortgage each month together with any other debts you may have, your household costs, and your living expenditures is what is meant by mortgage affordability. It denotes an economical house loan.
“Comfortably” is crucial. There must be cash left over after deducting all of your expenses from your income in order to serve as a safety net in case unanticipated expenses crop up.
There are two main reasons why mortgage affordability matters. Your credit report will reflect the late payment on your mortgage for a period of six years. Your credit score will be significantly lowered as a result, which will negatively impact your future prospects of obtaining a loan, mortgage, or even a phone contract. In the end, your house will be repossessed and sold to pay off your debt if you are unable to make the minimum payment required by your contract or to adhere to an assistance plan your lender has put in place.
Although it may seem frightening, repossession is not common. According to guidelines established by financial watchdog the Financial Conduct Authority, banks and building societies have an obligation to lend responsibly. This indicates that you are shielded from taking on excessive mortgage debt by the affordability check.
A mortgage affordability test: what is it?
Lenders use a mortgage affordability test to determine how much you can afford to borrow for a mortgage. This is to find out whether they could approve your mortgage application and how much they could lend to you.
In reality, a mortgage affordability test consists of two tests, which are as follows:
Multiple income
Income multiples are a tool used by banks and building societies to determine the maximum mortgage amount that they will provide you.
Assume that your annual income before taxes is £30,000. Your £30,000 salary would be multiplied by 3.5 by a lender utilizing an income multiple of 3.5 to achieve £105,000. It goes without saying that you combine your wages together and then use the lender’s multiplier if you’re purchasing with someone else.
For first-time purchasers, an income multiplier of 4.5 times wages is typical. Therefore, a single person earning £30,000 may receive a maximum mortgage offer of £135,00, whilst a couple earning £60,000 jointly could receive an offer of £270,000.
The majority of high street lenders will approve a mortgage that is 5.5 times the borrower’s pay provided they make at least £75,000 and have a deposit of 15% to 25%. However, first-time buyers who make £37,000 or more simply need to have a stellar credit history and a 5% deposit with a 5.5x Income Mortgage in order to be approved for a mortgage that is 5.5 times their earnings.
Professional mortgages, which let you borrow five or even six times your salary, are also available to those who work in professions like accounting, law, the NHS, or key worker positions.
A larger mortgage can also be obtained with family help. Your loved ones may help you with your purchase in a lot of ways without having a lot of cash up front. To learn more, go through the selection of guarantor mortgages that we recommend.
Evaluation of earnings and expenses
After determining the maximum amount of your mortgage, the lender will calculate how much of your monthly income (after taxes) you can use to pay it off after you’ve paid all of your other obligations and subtracted daily living expenditures.
Typical forms of income allowed are:
Basic income from employment and self-employment
benefits like the working and child tax credits
pension earnings
The rent from a rental property
You must include all of your usual outgoings, such as phone contracts, utilities, and council tax, as well as any monthly loan repayments, transportation expenses, childcare charges, school fees, grocery shopping prices, and money spent on hobbies, holidays, and socializing.
You should have enough money left over after deducting all of your expenses from your income to cover your mortgage payment plus a safety net. This way, even if interest rates rise, you can still afford to make your repayments.
Stress examination
The stress test required by a mortgage lender is not an assessment of your ability to handle strain. This test determines if you could continue to make mortgage payments even if interest rates increased by 3%. The remaining funds after completing your evaluation of your income and expenses must be sufficient to cover a mortgage with an interest rate that is 3% higher than the standard variable rate (SVR) offered by your lender.
Since the current average standard variable rate is 8.18%, being authorized requires you to be able to afford an interest rate of 11.41%. Although it seems high, it indicates that you have enough of room in your budget in case interest rates go up in the future. Selecting a five-year fixed rate is one method to get around the rigorous stress test. If you fix your rate for five years or more, some lenders will not stress test as much since they believe this lowers the borrower’s risk.