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Mortgage affordability - Jonathan Cornell

Mortgage affordability

One of the most common questions when a broker or an IFA speaks to a client is “how much can I borrow?” The answer used to be very simple a few years ago. Lenders used what were called “income multiples”. You simply multiplied your client’s income by a certain amount. For example a sole income earner could borrow 3½ times their income and with 2 earners they could borrow 2¾ times their combined salaries or 3 times one plus the other. When borrowers started to have significant amounts of unsecured borrowing, like credit cards, car and other loans lenders would typically deduct the annual repayments from the borrower’s salary before working out how much they could borrow.

Those days of blissful simplicity are now long gone. Most of the major banks and building societies have moved towards “affordability” based borrowing. Part of this was driven by improvements in technology and partly as a result of experience. Income multiples were very easy to use but they were a very blunt way of working out what is a crucial number. They treated everyone the same, irrespective of their financial position and the other circumstances in the lives. The simplest way to highlight their limitation is if you look at 2 borrowers on the same income, let’s say £40,000. Borrower one is single and has no dependents, borrowers two is married, is the sole income earner and has 4 children. Common sense tells us that in pure financial terms borrower one could support a larger mortgage than borrower two as they will have a much larger amount of disposable income left after paying all their bills. Affordability based lending models will take other factors into account before working out how much a borrower can afford.

The biggest problem is that using affordability models is very complex so it is very difficult for anyone to work out how much they can borrow. There are so many factors which can impact on the precise amount. These will vary from lender to lender but will include, number of dependents, salary banding (i.e. £25,000-£40,000, £40,001 -£60,000 etc), location, credit score, credit history, size of deposit , the interest rate, the list goes on and on. So how do these factors affect how much a borrower can afford? Number of dependents is simple to understand, with regards to salary banding, the bigger your salary the more you are likely to have left after paying your bills. Some lenders feel that borrowers living in London and the South East will face a higher cost of living than borrowers in other areas, so they are stricter with how much they will lend to these southerners. Credit score pays a huge impact on how much a borrower can afford but it’s the hardest to define. Borrowers past credit history will only play a small role. A multitude of factors go into calculating your credit score, these include your salary, job, employment sector, electoral roll information, past credit history, current credit history, address history, even factors such as whether or not you have a home phone number. The main thing to remember is that each lender will calculate a credit score in different way, one size doesn’t fit all. The funny thing is that everyone assumes they have a great credit score even when they have no idea how it works. A number of popular misconceptions are that never having borrowed money is a good thing. Well in credit score terms it definitely isn’t. Those borrowers who have never had a loan, mortgage or credit card are more of a mystery to lenders than those who have had credit in the past. Borrowers with a track record of paying their credit cards and loans on time will have a higher score. Borrowers who have had credit in the past but have missed any payments later than a month, been late with their credit card payments, had arrears or defaults will all now struggle to get a mortgage. In the boom lenders were happy to lend to borrowers who had had credit problems but those days are long gone.

For borrowers now the only real way of finding out how much they can borrow is to use the lenders system. Most lenders will have a basic kind of calculator on their web site. Borrowers should be careful though that if they do a “decision in principle” this may put a footprint on the credit file and if there are multiple footprints this may have a negative impact on their ability to borrow. Those who long for the simple days of income multiples need to realise that for the majority of borrowers, the downside of the complexity of affordability models is compensated by the fact that most borrowers will be allowed to take out a bigger mortgage compared with income multiples. I realise that all the way through this column I have spoken about people borrowing as much as the lender will allow. The vast majority of borrowers don’t actually need or choose to do this and just because a lender thinks you can afford to borrow a certain amount doesn’t mean you can.

Jonathan Cornell

Jonathan has been involved in the financial services industry for more than 15 years. He is current working a number of freelance projects, including working part time for First Action Finance as Head of Communications. He has a BA in Economics and an MBA. Jonathan lives in Guildford, Surrey is married and has a one year old son.

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