Mortgage Affordability

Understanding Mortgage Affordability

Understanding mortgage affordability is important for anyone looking to buy a property to ensure that you’re shopping within your budget.

It involves assessing how much you can realistically borrow based on your income, expenses, and other financial commitments.

At Kerr & Watson, we specialise in helping clients understand their mortgage affordability, ensuring you find the best mortgage solution tailored to your circumstances.

What is Mortgage Affordability?

Mortgage affordability refers to the amount of money a lender is willing to offer you for purchasing or refinancing a property.

It is determined by evaluating your income, outgoings, credit history, and other financial factors such as dependants or age. Lenders use this information to assess whether you can comfortably afford the monthly mortgage payments without undue financial strain to protect you from losing your home.

How Lenders Assess Mortgage Affordability

Income and Employment Status

Lenders look at your gross income, including your base salary and additional earnings such as bonuses, overtime, or commission using a certain percentage (or 100% depending on the lender).

For self-employed individuals, income assessments typically involve a review of the last two years of accounts or tax returns.

Salaried Employees: Lenders will generally take 100% of your basic salary into account. Additional income streams, like bonuses, commission, benefits or maintenance, may be considered at a reduced percentage depending on the lender.

Self-Employed: Income is usually calculated based on the average of the last two years’ earnings, some using latest year. Some lenders may accept an accountant’s certificate or projections if income is stable or increasing.

Outgoings and Financial Commitments

Your monthly outgoings play a significant role in determining mortgage affordability. This includes regular expenses such as utility bills, loans, credit card payments, and any other debts. Lenders also consider your cost of living, including food, transport, and other essential expenses. They will likely look through your bank statements to understand your spending, otherwise using ONS data.

Credit History and Score

A good credit score enhances your borrowing potential by demonstrating reliable repayment behaviour. Lenders review your credit report to check for any missed payments, defaults, or significant debts. Being on the electoral roll and maintaining a stable address history can also positively impact your credit score which may mean you get a more competitive mortgage product. A broker would be able to assess this for you.

Key Factors Affecting Mortgage Affordability

Loan-to-Value Ratio (LTV)

The LTV ratio is the percentage of the property’s value that you are borrowing. A lower LTV ratio often results in better mortgage rates, as it represents a lower risk to your mortgage lender.

For example, an LTV of 75% means you are borrowing 75% of the property’s value and paying a 25% deposit. For instance, buying at £200,000 and putting down £50,000.

Deposit Size

The size of your deposit can significantly affect your mortgage affordability. A larger deposit reduces the LTV ratio, potentially securing you a lower interest rate and therefore reducing your monthly payments.

Mortgage Term

The length of your mortgage term also influences affordability. A longer term reduces monthly payments but increases the total amount of interest paid over the life of the loan. Conversely, a shorter term results in higher monthly payments but less total interest. This means that younger borrowers may be able to get more lending due to the increased time they have to repay this debt.

How to Improve Your Mortgage Affordability

Increase Your Deposit

Saving for a larger deposit can improve your mortgage affordability by reducing the amount you need to borrow and potentially securing a lower interest rate.

Reduce Existing Debts

Paying off existing debts can improve your debt-to-income ratio, making you a more attractive borrower. It also increases the amount of disposable income available for mortgage repayments. You should get professional advice here as repaying debts does not always boost lending capacity.

Improve Your Credit Score

Ensure you pay bills on time, reduce existing debt, and avoid applying for new credit shortly before applying for a mortgage. Regularly check your credit report for errors and rectify any issues promptly. Add yourself to the electoral roll if you are not already on there.

You can find out your credit profile by going to Check My File.

The Impact of the Cost of Living Crisis on Mortgage Affordability

Recent economic challenges, such as rising living costs, have impacted mortgage affordability. Lenders are increasingly cautious, adjusting their lending criteria and stress-testing applicants’ ability to afford repayments if interest rates rise. They do this by making amendments to their affordability calculators so a loan amount that may have passed 6 months ago, may not pass today.

Restrictive Income Multiples

Previously, lenders might have offered loans up to six times your annual income. However, due to economic uncertainty, many lenders now cap this at 4.5 – 5 times income, reducing the maximum loan amount available. Certain lenders can go beyond this though, often for higher incomes or professionals who are due to earn more later in their careers such as lawyers or doctors. Your mortgage adviser will be able to look at what products you may be eligible for.

Stress Testing

Lenders conduct stress tests to ensure you can afford repayments if interest rates increase. These tests are now often set at higher thresholds, requiring borrowers to demonstrate affordability at interest rates significantly above the current market rates. For instance, if a product was 4.5%, the stress test may be at 8.5%. Lenders all have different stress tests.

Budgeting and Planning to Boost Your Mortgage Affordability

Improving your mortgage affordability often starts at home with good old-fashioned budgeting. Lenders look closely at your disposable income – what’s left after all your bills and expenses – to decide how much you can comfortably borrow. By creating a detailed monthly budget, you can identify areas to save money and increase that disposable income.

Start by listing all essential outgoings (rent, utilities, groceries, loan payments, etc.) and see if there are non-essentials you can trim. Perhaps you can cut down on subscription services or dining out, and redirect those funds into savings or paying off debts. Using our Budget Planner can simplify this process, giving you a clear overview of your finances.

Another tactic is to simulate future costs: if you’re aiming for a certain mortgage amount, use a mortgage repayment calculator to estimate the monthly payments, then practice living with that payment. Set aside that amount each month to see how it fits your budget – this not only boosts your savings (which can go towards a deposit or fees) but also conditions you to the mortgage lifestyle.

Additionally, planning for one-off costs like stamp duty, legal fees, and moving expenses is important; if you budget for these in advance, you won’t deplete your savings unexpectedly, leaving your day-to-day finances intact.

Remember that consistency is key – showing a lender that you manage your money well over time can positively influence their assessment of your affordability. With disciplined budgeting and financial planning, you’ll not only increase the amount you might be able to borrow, but you’ll also feel more confident that you can handle the costs of homeownership.

Conclusion

Mortgage affordability isn’t just about numbers on a page – sometimes you need expert insight to truly maximise what you can afford. This is where speaking with a mortgage advisor can make all the difference. An experienced advisor will review your unique situation and might spot opportunities that a generic calculator can’t. For instance, you may be eligible for specialist lender programs or niche products if you have bonus income, self-employed earnings, or other less-common income streams that mainstream lenders might undervalue.

A broker can ensure these additional earnings are presented correctly to count towards your affordability. Advisors also stay up-to-date on market changes – for example, if lenders have recently relaxed their income multiples or introduced more generous affordability criteria, you’d want to take advantage of that.

They can guide you on the optimal timing for your application (perhaps waiting until a high-interest debt is paid off, or until you’ve received a pay rise or bonus).

Moreover, getting an Agreement in Principle (AIP) through an advisor can give you a realistic affordability benchmark early in your property search. This way, you won’t waste time viewing homes outside your price range. If you’re a first-time buyer, expert advice is even more valuable: you’ll learn about any government schemes or first-time buyer incentives that could effectively boost your budget.

In short, while you can do a lot on your own, consulting with a professional ensures no stone is left unturned in improving your mortgage affordability.

At Kerr & Watson, our goal is to empower you with knowledge and options, so you can confidently pursue a mortgage that truly fits your financial situation.

Contact us today for expert advice, providing personalised support tailored to your unique needs.