Buying a home is one of the most significant financial decisions that anyone can make. A mortgage is a long-term financial commitment, and it's essential to ensure that borrowers can afford their repayments over the term of the loan. In the UK, lenders are required to follow strict affordability criteria set by the Financial Conduct Authority (FCA) to ensure that borrowers can afford their mortgage repayments.
But what criteria help determine the amount the homebuyer can borrow? It depends on various factors, including their income, expenses, credit score, and the lender's criteria. Lenders use a combination of factors to calculate affordability and ensure that the borrower can afford the mortgage repayments.
The first factor that lenders consider is the borrower's income. Lenders will assess the borrower's employment status, job security, and income stability to determine how much they can afford to repay. Lenders will typically look at the borrower's gross income, including any regular overtime, bonuses or commission payments, and any other sources of income such as rental income.
The second factor is the borrower's expenses. Lenders will look at the borrower's monthly expenses such as utility bills, council tax, insurance, and other debts such as credit cards or personal loans. Lenders will also consider other regular monthly outgoings, such as childcare or travel costs.
The third factor is the borrower's credit history. Lenders use a borrower's credit score to assess their creditworthiness and determine the risk of lending to them. The higher the credit score, the better the chances of getting approved for a mortgage and obtaining a favorable interest rate. Borrowers with a poor credit history or low credit score may find it more challenging to get approved for a mortgage or may have to pay a higher interest rate.
The fourth factor is the deposit amount. A larger deposit reduces the amount of borrowing required, and therefore the monthly repayments. Lenders in the UK typically require a minimum of 5% deposit, but higher deposit amounts can help to secure better interest rates and improve affordability.
The fifth factor is the property's value. Lenders will look at the value of the property being purchased to determine the loan-to-value (LTV) ratio. The LTV ratio is the percentage of the property's value that the borrower is borrowing. For example, a borrower purchasing a property worth £250,000 with a £50,000 deposit would require a mortgage of £200,000, resulting in an LTV of 80%.
To ensure that borrowers can afford their mortgage repayments, lenders in the UK will assess affordability by looking at the borrower's income and expenses to calculate their debt-to-income (DTI) ratio. The DTI ratio is the borrower's total monthly debt payments divided by their gross monthly income. Lenders typically prefer a DTI ratio below 43%, although some may go up to 50%. However, it's important to keep in mind that the lower the DTI ratio, the better the chances of getting approved for a mortgage and obtaining a favourable interest rate. The lender will also stress the borrower’s repayment in the majority of cases to ensure that they could afford the repayments if interest rates go up.
The last thing that mortgage lenders or the broader industry want is borrowers who fall into arrears or worse have to think about selling their properties to avoid a default. That is why a lender’s criteria is so strict, which makes borrowers more resilient to changes in interest rates, but will make it harder for them to find the right mortgage on their own.
OnLadder’s Non-Executive Director, Jackie Bennett elaborates:
First time buyers are not alone in navigating this process though. To determine how much someone can afford on their mortgage, it's essential to speak with a mortgage broker who can assess the borrower’s financial situation and provide guidance on the maximum amount they can borrow and the right mortgage for them. Brokers can also provide a broader view of the market, allowing borrowers to save time and to save the stress of finding the most suitable deal for their financial circumstances and ensures they can afford their repayments over the term of the loan.