Mortgage Affordability – A Definitive Guide

Introduction to mortgage affordability.

One of the metrics used to accept or decline a mortgage is mortgage affordability. By this we mean that a lender bases the maximum amount you can borrow on an affordability calculation. It’s important to note that they will not only assess your income but your outgoings as well.

Types of outgoings or expenditure, by order of importance:

• Committed Expenditure –loans, credit cards, child maintenance payments, etc.
• Basic Living Costs – Council tax, utilities, commuting to work, etc.
• Quality of life costs – Clothes, entertainment, etc.

A lot of lenders us office of national statistics (ONS) data for basic living costs and quality of life cost when making their affordability calculations.

A little History lesson.

The rules implemented that requires mortgage lender to assess applicant affordability are due to the Mortgage Market Review (MMR). This was an investigation after the 2008 credit crunch into the mortgage market. The outcome of that was a set of new rules that came into force on 26^th April 2014 and changed the way mortgages are regulated.

Why mortgage lenders need to asses affordability.

Mortgage lenders need to assess your affordability for many reasons, to make sure you can afford to repay the mortgage and keep up with the monthly mortgage payments. Lender do not want any mortgage payment arrears under any circumstances. They also have a duty of care that they don’t sell you a mortgage that you cannot afford. This is expected of them because of rules set by the regulator, the financial conduct authority FCA.

The mortgage lenders want to be certain you can afford your mortgage because they do not want you to be unable to pay or late to pay. The cost of repossession and disposal is high and nobody wants it to come to that.

It is interesting that house repossessions reached an all-time low in 2019. That could be interpreted as evidence that mortgage affordability rules are working. The statistics for repossessions 4,580* repossessions in 2019 compared with a high in 2009 of 48,900*.

The most dramatic decline does appear to happen once the Mortgage Market Review (MMR) comes into force.

The government body responsible for regulating the mortgage market is the Financial Conduct Authority FCA. Its the FCA who have imposed the new rules on the mortgage lenders, giving them a duty of care to lend responsibly and carry out mortgage affordability tests.

These affordability rules are also the responsibility of your mortgage adviser or broker. This is why they go through a budget with you.

The FCA publishes the Mortgages and Home Finance: Conduct of Business sourcebook MCOB. This governs the relationship between mortgage lenders and borrowers in the United Kingdom.

An extract from MCOB 11.62.2

• before entering into, or agreeing to vary, a regulated mortgage contract or home purchase plan, a firm must assess whether the customer (and any guarantor of the customer’s obligations under the regulated mortgage contract or home purchase plan) will be able to pay the sums due
• the firm must not enter into the transaction in (a) unless it can demonstrate that the new or varied regulated mortgage contract or home purchase plan is affordable for the customer (and any guarantor).

Sources of information:

https://www.bbc.co.uk/news/business-47239360
https://www.gov.uk/government/statistical-data-sets/live-tables-on-repossession-activity
https://www.handbook.fca.org.uk/handbook/MCOB/11/6.html

How mortgage lenders assess affordability.

Mortgage lenders will assess affordability using two things, your income and you’re out goings. What makes it complicated is that not all lenders do things the same. The rules they abide by are open to some interpretation. If lenders did not asses expenditure as well as income then a rudimentary income multiple could be used.

Although rudimentary income multiples still have there place somewhat, as a very rough guide. They cannot be relied upon as it does not account for outgoings, most maximum lending is capped somewhere in the range of 4.5x, 4.75x and 5x a borrower’s income. Although 5x is rare and only available to those that fit other criteria, for example earn over £75k per year or have a loan to value under 50%.

When it comes to income most lender use your gross pre tax income. This might include income from a salary, overtime, commission, certain allowances, government benefits and self-employed income.

See post here about how lender asses self-employed income.

Mortgage lenders will also look at an applicant’s expenditure. These can be categorised into 3 types:

• Committed Expenditure – Loans, credit cards, child maintenance payments, child care, etc.
• Basic Living Costs – Council tax, utilities, commuting to work, etc.
• Quality of life costs – Clothes, entertainment, etc.

The most important is committed expenditure as these are fixed costs that cannot be reduced. These also vary a lot person to person so are always specifically asked for by mortgage lenders and then used in their calculations. The other two categories can be somewhat variable and in a lot of cases mortgage lenders will use office of national statistics (ONS) data

Source of income used for affordability.

Mortgage lenders will use many types and sources of income when making affordability assessments. However not all mortgage lenders are the same and incomes one lender might accept others may not.

Here is a list of some of the incomes that lenders consider.

Pay from employment.

Affordability Calculator – Estimated