Mortgages - How Lenders Work Out Affordability

Posted by Nick Niesen on October 29th, 2010

If you are thinking about purchasing a property it is first important to know how much you can afford to borrow. Mortgage Lenders traditionally used income multiples to work out this amount.

If an applicant was earning 30,000 a year the lender would calculate that they could comfortably afford to borrow 3.5 x their income which is 105,000. If approached with a joint application, lenders would add the two incomes together say 30,000 and 16,000; this would make their total income 46,000. To work out how much the couple could borrow they would then multiply this figure by 2.5, this would make a total of 115,000.

However these affordability practices have now become outdated with house price inflation and low interest rates, these factors have made the cost of borrowing a mortgage cheaper.

Why The Practice Has Changed?

In the last few years mortgage lenders have started to offer larger amounts, they have increased the income multiples to for example 4 or 5 times salary. Since the property house price boom, this is often required to give buyers a chance of meeting market prices and seller expectations.

Repossession of property is currently at a historically low level and people have more disposable income making it easier to pay their mortgage. 50 percent of lenders now work out how you can borrow depending upon your ability to pay as opposed to the income multiple criteria discussed above.

This means that everyone applying for a loan is not assessed in the same way, the majority of lenders will be offered more money via this method, some however may not, for example single mothers.

How Affordability Is Calculated

Every lender has a different method for working out how much they are prepared to lend you. All of them will however ask for proof of income, number of dependents, other monthly commitments (credit cards, store cards, etc), and your essential household spend.

Interest rates will also affect your repayments. Unless you choose a fixed rate mortgage, which keep interest on the mortgage at a fixed rate. Interest rate rises can affect a borrowers ability to repay, so it is an important consideration when taken out a mortgage.

How To Avoid Get Into Problems

It is your responsibility to ensure that you do not borrow more than you can afford, banks and lenders obviously have precautions in place to protect their investment, interest rate fluctuations and other potential commitments have to be taken into consideration before taking out a mortgage that could leave you in trouble.

Check out some online mortgage calculators as this will lay out the figures clearly in front of you so you can consider your options.

If you are a first time buyer it is important to take into account some other outgoings such as buildings insurance, mortgage payment insurance, etc.

Read the Key Facts illustration from your lender or broker this will show you the difference interest rate rises or falls can make to your payments.

If you choose a fixed rate deal dont forget you may only be on a low rate for a short period of time after which time your rate can suddenly increase.