hen you embark on a home search, figuring out how much you can afford to borrow on a mortgage should be your first stop.
Unless you’re lucky enough to be a wealthy cash buyer, your spending limits will determine not only what type of property you can afford, but also its location. This article explains the nuts and bolts of mortgage affordability.
How much can you borrow?
The amount of mortgage you can get depends on what you earn, save and spend.
Any savings or other money that you have accumulated that can be spent on purchasing a property is known as a deposit. The amount of property already owned by an existing owner (‘equity’), can also count as a deposit the next time they move out.
To secure a mortgage, whether you’re a first-time buyer or an experienced homeowner, most lenders require potential borrowers to make at least a small deposit. Let’s say 5% of the purchase price.
Amount of the loan
The amount you borrow against a property’s value is called the loan-to-value ratio, or LTV for short. This figure is expressed as a percentage. A down payment worth 10% would require the borrower to take out a mortgage with an LTV of 90% in order for the real estate transaction to proceed.
The higher a buyer’s deposit can be, the more flexibility and better interest rates that lenders such as banks and building societies are likely to offer are likely to be offered.
A question of income
When it comes to income, lenders use “multiple income” to do their loan calculations. They add up the combined total salary of the applicants and multiply it by a number to produce a maximum mortgage amount.
An income multiple of up to 4.5 times the total salary is the norm. For example, a couple with a combined family income of £ 80,000 could potentially borrow £ 360,000.
But this is more of a rule of thumb than a hard and fast rule, as different mortgage lenders will offer varying amounts as a loan.
In terms of proof of income, the self-employed face a greater challenge as their employment status is considered less secure.
If you work for yourself, a lender may ask for proof of income going back three years. Details of your self-assessment arrangements for tax purposes are also required, along with a SA302 document. The latter relates to the proof of earnings as provided by HM Revenue & Customs.
Even with a generous income multiple and a decent deposit, how much you can borrow will be more determined by your spending habits and unpaid debts. In other words, what is actually available each month to pay off a mortgage.
This is called an affordability check, and it can reduce or inflate your borrowing, depending on how tight the lender’s control is.
Mortgage applicants must provide a history of their bank statements, showing how they spend their money. This clarifies for the lender whether potential borrowers can afford mortgage payments in accordance with their lifestyle.
This includes looking at how much you spend on monthly bills, including energy, broadband, and cellphones, as well as other regular expenses such as transportation and childcare. Additionally, you may be asked how much you spend on vacation and meals out.
Lenders must also apply what is called a “stress test”. This checks a client’s financial resilience and examines not only what borrowers can afford now, but also what would happen if economic conditions turned against them in the future. For example, if their mortgage payments were to increase because of an increase in interest rates.
Stamp duties and legal fees
People sometimes forget the impact of stamp duties and legal fees when they start looking for housing. It is essential that these are factored into the calculations as bills can run into the thousands of pounds, which can hurt a deposit and therefore affect how much you can borrow.
Stamp duty works differently in each of the deconcentrated nations, but is essentially linked to the purchase price of the good in question. In England it is called Stamp Duty Land Tax, while in Wales it is called Land Transaction Tax.
Payment of the tax is due, unless the value of the transaction is within a range known as “zero rate”. At the time of writing, slightly different stamp duty rules apply to first time buyers compared to homeowners already on the real estate ladder.
With house prices so much higher in London and the South East than in the rest of the UK, buyers in this region often face a higher slice of stamp duty. Find out how much you may have to pay using the Stamp duty Property tax calculator.
What to do next?
Preparation is essential and to help you do that, you can hire the services of a mortgage broker.
They can walk you through affordability checks, loan criteria from various banks and building societies, and the types of mortgages available. Some brokers charge for their services, while others are free and charge a commission from the lenders instead. Ask about the fee template a broker uses at the start of any meeting.
To get an idea of what’s possible, use an online mortgage calculator. Most lenders have one on their websites. Just because you can borrow a large amount of money doesn’t always mean you should.
It is also a good idea for all potential borrowers to check their credit reports before applying for a mortgage. Every adult with a history of borrowing has a credit report, which lenders refer to to judge whether or not you are a safe bet for a home loan. Use a credit reference agency to access your file, such as Experian, Equifax, or TransUnion.
As you get closer to finding a home, consider getting a “principle mortgage” also known as a “tentative agreement”. This is where you give the lender a more detailed picture of your finances. In return, you will get an idea of how much you can borrow.
This does not guarantee you the transaction, but gives you the reasonable expectation of getting a mortgage of this size. Ultimately, the goal for potential borrowers is to save money, budget and, if necessary, seek expert advice.