WHEN YOU APPLY for a mortgage, the lender’s decision on how much you can afford to borrow can seem like a mysterious one. But there’s no magic or secret behind the outcome, just a simple affordability formula.
Here are the factors the mortgage lender will consider.
YOUR INCOME
In the past, your income was the only factor that mortgage providers would base their decision on. But now, with the Mortgage Market Review (MMR) rules in place, lenders are required to take a more holistic approach. This means that your income is only one part of the underwriting equation.
Some mortgage lenders may offer larger loan amounts to people in certain professions with higher earnings or higher combined household incomes. In some cases, the income multiple you’ll be eligible for can also depend on the loan-to-value ratio you’re borrowing at.
Having a guarantor help you could allow you to borrow more money using a guarantor mortgage. Or perhaps a JBSP mortgage or joint mortgage with parents might be more suitable.
For CIS registered construction workers there could be advantages to using a CIS mortgage scheme, rather than a standard self employed approach.
Are self cert mortgages still available?
YOUR OUTGOINGS
Lenders will also look at your current outgoings – things like rent, credit card repayments, student loans and any other loans you have. They’ll also take into account your regular expenditure, like food shopping and travel costs.
YOUR DEBT-TO-INCOME RATIO
Your debt-to-income ratio is one of the most important factors in deciding how much you can afford to borrow. This is the percentage of your monthly income that goes towards repaying debts.
For example, if your monthly income is £3,000 and your monthly debt repayments are £600, your debt-to-income ratio would be 20%.
What is a debt to income ratio?
YOUR DEPENDANTS
If you have any dependants, like children or elderly parents, this will also be taken into account. This is because you’ll need to make sure there’s enough money left over each month to cover the costs of looking after them.
YOUR AGE
Your age can also play a part in how much you can afford to borrow. This is because your mortgage term will usually end when you reach retirement age (usually 65-70). So if you’re approaching retirement, not all lenders will offer you such a large mortgage. You might find our guide to Borrowing into Retirement useful reading.
YOUR PROPERTY’S VALUE
The value of the property you’re looking to buy will also be taken into account. This is because lenders will only offer you a loan worth up to a certain percentage of your property’s value (known as the loan-to-value or LTV ratio).
For example, if you’re looking to buy a property worth £200,000 and have a 10% deposit of £20,000, your loan-to-value would be 90%.
What to consider before making an offer on a house?
WHAT LOAN-TO-VALUE RATIO SHOULD I BE AIMING FOR?
The higher the loan-to-value ratio, the higher the risk for the lender. This is because there’s a greater chance that you could end up owing more than your property is worth if house prices fall.
Lenders will often offer better mortgage rates to borrowers with a lower LTV ratio.
YOUR CREDIT SCORE
Your credit score is another important factor in deciding how much you can afford to borrow. This is because it gives lenders an idea of how well you’ve managed your finances in the past.
If you have a good credit score, it’s likely that you’ll be able to borrow more than someone with a bad credit score. This is because lenders will see you as a lower-risk borrower.
Read our Guide to Credit Reports for a more detailed view.
YOUR MORTGAGE RATE
The interest rate you pay on your mortgage will also have an impact on how much you can afford to borrow.
For example, if you have a mortgage with a low interest rate of 2%, your monthly repayments will be lower than if you had a mortgage with a higher interest rate of 4%.
This means you’ll have more money left over each month to cover the costs of running your home. Some lenders will offer higher loan amounts where a five year fixed rate is chosen, as the affordability won’t be affected by interest rate rises. There’s also a mortgage stress test, which some lenders use to see how you would cope if interest rates went up.
Before you apply for a mortgage you should receive a mortgage quote, or key facts illustration (KFI). This will detail the monthly costs, fees and interest rate including the APRC.
YOUR DEBT POSITION
Outstanding debt is an important factor in deciding how much you can afford to borrow. This is because your mortgage repayments will need to be affordable after you’ve taken into account your other debts.
Your debts can include things like:
- Credit card debts
- Personal loans
- Car finance repayments
- Student loans
Mortgage lenders will usually want to see proof of your debts, such as bank statements or loan agreements. They’ll use this to calculate your debt-to-income ratio. This is a key factor in deciding how much you can afford to borrow.
REPAYMENT METHODS
The vast majority of borrowers will set up their new mortgage on a repayment basis, sometimes also known as capital and interest. This means that each month you pay the interest you owe plus a bit of the debt, gradually reducing the balance.
By opting for an interest only mortgage you may be able to borrow more money. This is because the payments for an interest only loan are quite a bit cheaper than for repayment, and so your mortgage affordability is better.
Here’s a quick example:
- £450,000 mortgage over 25 years at 4%
- Repayment mortgage = £2375pm
- Interest only mortgage = £1500pm
This option is not right for everyone. Take a look at our Guide to Interest Only Mortgages to learn more.
How much does the average mortgage cost?
Can I change my mortgage to interest only?
Is a marathon mortgage right for you?
COMPARE LENDERS
Though mortgage providers all use broadly the same affordability criteria when deciding how much to lend you, each has their own specific requirements during the mortgage underwriting process. This is why it’s important to compare different mortgage deals to find the one that’s right for you.
It can be time-consuming to find the provider that will lend you the money you need. But an independent mortgage broker can work with you to find the best arrangement.
