How Lenders Calculate How Much You Can Afford To Borrow, And Is That About to Change?
A recent independent study has shown that brokers have overwhelmingly called for lenders to take a more affordability-driven approach to product development, and there is a demand for lenders to make greater use of available affordability data in their product development.
Most respondents (86%) also believe that mortgage affordability has become more complex than ever, with many lenders applying different rules.
Many people will feel frustrated when you know you can afford the monthly repayments on paper, but the Lender says you can't. Or when you have been paying more in rent for several years than the proposed mortgage payment, but the Lender says no. And why is it when you put your details into affordability calculators online, each Lender gives you a different result, sometimes wildly different?
You will probably know that your creditworthiness, income, and credit commitments are significant factors when determining affordability. But did you know two additional elements sit deep inside Lenders' systems to determine affordability? Read on to get deep inside a Lender's mind and understand what makes them say yes or no to mortgage applications.
First of all, Lenders all have different appetites for risk, and that risk can change, sometimes at short notice. At any given time, complex systems calculate the risk and exposure a Lender has with its Mortgage lending. Suppose a lender can see that they are exposed to less risk than comfortable. They may loosen their affordability criteria allowing them to say yes to more mortgage applications. However, the opposite is also true. If a Lender has taken on more risk, their measures may tighten, leading to fewer accepted applications.
Secondly, Lender's don't use your actual mortgage payment when calculating whether it's affordable or not. Instead, they carry out what's known as stress testing, which means that they calculate the affordability of the mortgage payment at a higher rate than the rate for which you are applying. This is because the Bank of England imposes rules on those who lend for mortgage purposes and insist that they check that the mortgage is affordable should the interest rate rise by 3%. But many Lenders go beyond this additional 3% figure and add 3% to their current standard variable rate and test that figure to see if it's affordable.
Take a £100,000 repayment mortgage over 25 years. If the mortgage of £100,000 is less than 60% of the property's value, the lowest fixed rate at this time is just under 1%, whereas the same Lender's standard variable rate is 4.59%. Now add the 3% Bank of England stress test loading to the standard variable rate, and the Lender is checking affordability not on 0.96% but a whopping 7.59%. So to illustrate, a £100,000 repayment mortgage over 25 years will cost £375pm at 0.96% but will cost £745pm at 7.59%, almost double. And your affordability of the mortgage is being assessed at £745pm, not £375pm.
So what's changing? The Bank of England has now entered into a consultation period to determine whether, in the current climate, the 3% rule may be detrimental to the consumer and is preventing the housing market from working fluidly. The Guardian has reported that this change should benefit many people who fall foul of the current rules, which is fantastic. Of course, this doesn't mean that stress testing at a higher rate will be eradicated. But it may provide more autonomy to mortgage Lenders who can set their stress testing levels to match their appetites for risk at any given time.
Ian Angus-Felton, Senior Broker and Technical Manager at Greenshoots Financial, said, "We welcome the Bank of England consultation as it may lead to Lenders being able to assess borrowers' affordability on a more individual basis rather than a standardised basis as we see it today. If this leads to more people being granted mortgages and buying their dream homes, that must be good."
At Greenshoots Financial, we always perform a thorough affordability assessment for our clients before recommending the most appropriate mortgage for their circumstances. We take our responsibility for this very seriously. We won't hesitate to point out to a client if what they are proposing to borrow is beyond their means.