What is my mortgage affordability? Everything you need to know

When it comes to applying for a mortgage, many customers are not fully aware of the extent of the testing lenders carry out to work out what they can afford.

Comprehensive tests are employed based on information provided to lenders by the prospective homebuyer.

They are necessary in order to protect the customer from potentially losing their home and the lender from losing their money.

Here, independent mortgage broker John Charcol explains the whole process.

What is your affordability?

Your affordability is essentially how much you can afford to borrow as a mortgage.

Lenders work out your affordability by looking at:

Your gross annual income

Your monthly disposable income– i.e. your total monthly income after expenses/outgoings.

Some lenders will take bonuses or commission into account if they’re a regular part of your income. However, most lenders won’t include 100 per cent of this income when working out your affordability.

They’re more likely to include about 50-60 per cent of any bonuses or commission as part of your gross income.

How do lenders work out your affordability?

Lenders work out your affordability by using a specific calculation. We go through the steps below.

1. The lender figures out maximum loan size

First, the lender calculates your maximum loan size, which is the maximum amount you could potentially borrow.

To work out your maximum loan size, most lenders will multiply your gross annual income by 4.5:

Gross income x 4.5 = maximum loan size

Some lenders will go up to five times your gross annual income:

Gross annual income x 5 = maximum loan size

This second calculation is usually only for certain professionals – for example doctors, accountants, vets and lawyers – and will only be applied in certain circumstances.

2. They calculate what you can afford in monthly payments

The second part of the affordability calculation is to do with what you can afford in monthly payments. The lender will work out what you can afford in monthly payments by looking at your monthly disposable income. Therefore, they’ll ask about any employer allowances, rental income or investment income you receive, etc. as well as your monthly salary/income. They’ll also want to know whether you have any outstanding debts or financial commitments as these will reduce your monthly disposable income.

3. The lender asks how much you would ideally like to borrow

The lender will then ask how much you would like to borrow and for how many years you would like the overall mortgage term to be. The mortgage term will have a major impact on whether you can afford the mortgage as it’s a major factor in determining your monthly payments.

4. They’ll carry out stress tests

Lenders also apply stress tests, where they work out what you could afford should interest rates increase.

5. The lender calculates what you can actually borrow

Once they have all the right information, the lender will calculate how much you can actually borrow and how this compares to what you’d ideally like to borrow.

Why can’t you borrow as much as you want?

It’s important that a lender works out your affordability correctly to avoid irresponsible lending. If they were to lend you too much, to the point where you couldn’t pay it back, you’d risk losing your home and they’d lose money; no one would benefit.

So, if you find out you can’t borrow as much as you would have liked to, remember that it’s probably for the best.

Where does it come into the mortgage process?

Lenders calculate your affordability as part of your DIP (Decision in Principle). You secure a DIP before submitting your full mortgage application.

It’s essentially a written promise from the lender that they’ll loan you a certain amount of money, so long as the information you’ve provided them with is correct.

Why do you need to know this?

Most people want to borrow as much as they can. However, a lot of them don’t realise that the credit commitments they take out now will affect what they can afford.

So, if you want to borrow near the maximum of what you can afford, you should minimise your financial commitments to maximise your net disposable income.

That way, you’ll be able to borrow as much as possible within the limits of the affordability calculation. Avoid signing onto other monthly credit commitments – e.g. credit cards, loans, store cards, car finance – if you intend on applying for a mortgage in the near future.

For further mortgage guidance, please visit charcol.co.uk/onthemarket

Or you can book your free consultation with a John Charcol mortgage adviser by calling 0333 242 8556.

OnTheMarket receives an introducer fee from John Charcol of up to 30 per cent of the value of the fees paid by the mortgage lender to John Charcol for each successful mortgage application arranged by them.

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