26 min
#22 - What is Affordability and how does it affect me? ReadytoBuyPodcast
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- Home & Garden
It might sound like a really simple concept, and ultimately it is - is something affordable?
In a mortgage context, the concept of affordability is a relatively new term and concept.
Historically - income multiples determined how much you could borrow.
Background
In the early 2000s, lenders used to lend you 2.5 x your combined annual income if applying for a mortgage as a couple or 3 x your income if applying alone.
With the explosion of house prices in the last 25-30 years, there is a need to have greater flexibility when it comes to affordability.
Regulation in this industry has increased during this time, initially by Financial Services Authority (FSA), and more recently renamed the FCA (Financial Conduct Authority).
As a result - affordability was introduced – which goes a step further than simply looking at income multiples, which was quite a crude measure of how much you can borrow.
Whilst many lenders still use income multiples that sit behind their calculations, there's very much more emphasis placed on the affordability on a monthly basis – i.e. how much is coming in each month and how much is going out.
In very simple terms, affordability is what’s left after deducting your outgoings from your income.
IncomeIt’s rarely this simple though as there are so many different types and parts to your income.
In the simplest example, you might be an employee with a fixed basic annual salary.
However, you might have additional income such as:
Bonus (monthly, quarterly or annual)CommissionOvertimeAllowances (Car, Shift etc)
If self-employed, you could be a sole trader, a limited company director, contractor or Limited Liability Partner (LLP). We saw in episode 21 how lenders may use different income depending on your set up and their own internal rules.
You may receive other types of income such as; child benefit, tax credits, child maintenance etc
Lenders often have a different approach to each other too – which explains why you may be offered differing mortgage amounts from different lenders.
OutgoingsMany different forms of outgoings and again may be treated in a different way by different lenders
Credit commitments – loans, car finance, credit cards, store cards etcChildcare costs – nursery, childminder, nanny etcChild Maintenance Travel CostsHousehold expenditure
Lenders will tend to use the Office of National Statistics (ONS) data, when they factor in a lot of these, so that will tend to take an average.
Lending DecisionsLenders will balance two main things when deciding whether to grant your requested mortgage:
Affordability - Ultimately, how much of your income is left over after all of the above outgoings is the important figure to them. Is it sufficient for your mortgage payment now and if rates increase?Credit Risk - is essentially the lender gauging the risk of you as a borrower not paying your mortgage back
They'll look at all sorts of data that they've got for people in similar situations to you historically, along with viewing the conduct of your credit agreements on your credit file before reaching their decision
As with affordability, credit risk policy will vary between lenders – explaining why some may provide different decisions
“DEFINITELY NOT A SILLY QUESTION” Feature
Q – I’ve got a loan I intend to repay before my new mortgage starts. Will this affect the affordability calculation?
A – It may do, depending on the lender. Most lenders...
It might sound like a really simple concept, and ultimately it is - is something affordable?
In a mortgage context, the concept of affordability is a relatively new term and concept.
Historically - income multiples determined how much you could borrow.
Background
In the early 2000s, lenders used to lend you 2.5 x your combined annual income if applying for a mortgage as a couple or 3 x your income if applying alone.
With the explosion of house prices in the last 25-30 years, there is a need to have greater flexibility when it comes to affordability.
Regulation in this industry has increased during this time, initially by Financial Services Authority (FSA), and more recently renamed the FCA (Financial Conduct Authority).
As a result - affordability was introduced – which goes a step further than simply looking at income multiples, which was quite a crude measure of how much you can borrow.
Whilst many lenders still use income multiples that sit behind their calculations, there's very much more emphasis placed on the affordability on a monthly basis – i.e. how much is coming in each month and how much is going out.
In very simple terms, affordability is what’s left after deducting your outgoings from your income.
IncomeIt’s rarely this simple though as there are so many different types and parts to your income.
In the simplest example, you might be an employee with a fixed basic annual salary.
However, you might have additional income such as:
Bonus (monthly, quarterly or annual)CommissionOvertimeAllowances (Car, Shift etc)
If self-employed, you could be a sole trader, a limited company director, contractor or Limited Liability Partner (LLP). We saw in episode 21 how lenders may use different income depending on your set up and their own internal rules.
You may receive other types of income such as; child benefit, tax credits, child maintenance etc
Lenders often have a different approach to each other too – which explains why you may be offered differing mortgage amounts from different lenders.
OutgoingsMany different forms of outgoings and again may be treated in a different way by different lenders
Credit commitments – loans, car finance, credit cards, store cards etcChildcare costs – nursery, childminder, nanny etcChild Maintenance Travel CostsHousehold expenditure
Lenders will tend to use the Office of National Statistics (ONS) data, when they factor in a lot of these, so that will tend to take an average.
Lending DecisionsLenders will balance two main things when deciding whether to grant your requested mortgage:
Affordability - Ultimately, how much of your income is left over after all of the above outgoings is the important figure to them. Is it sufficient for your mortgage payment now and if rates increase?Credit Risk - is essentially the lender gauging the risk of you as a borrower not paying your mortgage back
They'll look at all sorts of data that they've got for people in similar situations to you historically, along with viewing the conduct of your credit agreements on your credit file before reaching their decision
As with affordability, credit risk policy will vary between lenders – explaining why some may provide different decisions
“DEFINITELY NOT A SILLY QUESTION” Feature
Q – I’ve got a loan I intend to repay before my new mortgage starts. Will this affect the affordability calculation?
A – It may do, depending on the lender. Most lenders...
26 min