Introduction

Understanding how much you can borrow for a mortgage is crucial for anyone looking to buy a property, whether for residential or buy-to-let purposes. The process involved is often a lot more complex that people realise, especially since the credit crunch where the regulators tightened up the rules around what banks can lend. This guide provides an in-depth look at mortgage affordability, covering both residential and buy-to-let mortgages. We will explore how affordability is calculated, the regulatory limits in place, and strategies to maximize your borrowing potential. By the end of this article, you’ll have a clear understanding of the factors that influence mortgage affordability and how to know where you stand and how to maximise your borrowing.

Residential Mortgage Affordability

Overview of How Affordability is Calculated

Mortgage affordability for residential properties is typically calculated by assessing your gross income, that is before tax, and deducting essential and committed expenditures. Essential expenditure includes living costs such as food, utilities, and transportation, while committed expenditure covers existing debt repayments and other financial obligations like childcare and service charges. The remaining disposable income is then analysed to determine what portion can be allocated towards mortgage payments, ensuring that you can comfortably afford the loan without financial strain.

Typically lenders want to see that the mortgage payment will not exceed about 75% of the disposable income left after the above has been taken into account. It’s this distinction that can lead to some surprising outcomes. Below we will look at what constitutes committed expenditure and how essential expenditure is worked out, the factors that also influence max loans and some examples of the variance in results between different lenders and scenario’s

Regulation

Regardless of the calculations one important factor must be understood. The Prudential Regulation Authority (PRA) that regulated banks to ensure economic stability, as opposed to the Financial Conduct Authority (FCA) which regulates all financial services to ensure good outcomes for customers, mandates that lenders must not lend more than 4.5x an applicants gross income except for about 15% of its customers. As a result lenders who will go over 4.5 times income will be looking to do so for the safest borrowers and that threshold may change unpredictably.  As a result we should start by assuming that 4.5 times income is going to be a limit for most people. If two applicants earn £50,000 each then the likely max loan across most lenders will be £450,000. Those with larger deposits, 25% or more, lower borrowing, better credit scores etc are more likely to qualify for higher multiples, 5 times up to 5.5 or 6 times potentially.

Another factor here that might contradict this is where a customer is on a path to earning more money in a relatively short time, so doctors, lawyers and accountants who often start on lower salaries whilst in a structured training program but will most likely see a big increase in income can sometimes be considered for higher multiples on the basis their current income is temporary and future rises predictable.

Essential Expenditure vs. Committed Expenditure

Essential expenditure refers to the basic costs required to maintain a standard of living, such as housing costs, food, transportation, and utilities. These expenses are typically based on data from the Office for National Statistics (ONS) to ensure they reflect average living costs. Committed expenditure, on the other hand, includes fixed financial commitments like loan repayments, credit card debts, childcare costs, and service charges. Understanding the distinction between these types of expenses is crucial for accurately calculating mortgage affordability.

When taking living costs into account lenders will want to know if costs exceed the average. Averages are based on the household demographics, ie number of adults, number of children, retired or working etc. They are also based on postcode area and are freely available to review on the ONS website. As a result if you are particularly budget conscious you might find that it doesn’t really benefit you as lenders will still default to the average in your area. The reverse is sadly not the case. Lenders will look to see if you have above average costs they need to consider and take the largest!

Committed expenditure relates largely to debt payments. Loans, HP and other vehicle finance is taken as a monthly commitment, credit cards are considered based on between 3 and 5 percent of the outstanding balance. One thing to note is that some lenders will still factor a balance that you say you will pay off, or at least some of it. Their rationale is that they cannot always control you paying them off after completion and have to hedge their bets. As a result sometimes its crucial to settle any loans or credit cards before or during an application to ensure it reflects in the max loan amount.

Other costs that are frequently factored include school fee’s, childcare, travel expense such as season rail tickets as well as service charges and ground rent for leasehold properties, the latter being a concern where you have doubling ground rents.

Other Influencing Factors

Several other factors influence mortgage affordability. The number of dependents, such as children, can significantly impact your disposable income because of the significant increase in average essential expenditure from the ONS. The term length of the mortgage also plays a role; longer terms can reduce monthly payments but may increase overall interest paid. Loan-to-Value (LTV) ratio, which is the percentage of the property’s value you wish to borrow, affects both the interest rate and the amount you can borrow. Additionally, the type of income, whether from employment or self-employment, and current interest rates are critical factors in the affordability calculation.

There is still some caution surrounding self employment and lender will factor employed income as more stable. As a result you might find that with some lenders the same self employed income gives slightly lower max loans than the same  employed income. In addition self employed income is factored over between 2 and 3 years typically, although a few lenders will use the latest figure only.

Compared to employed income where lenders will even use the salary on a contract before an applicant even started, let alone has a payslip. Understanding self employed income types and circumstances is probably a blog post in and of itself, but for the purposes of this we will assume we have 2 years accounts available and taking the average of the two figures.

Strategies to Maximize Borrowing Potential

Because the process is heavily regulated, there is actually not a huge amount that can be done to influence the maximum loan you can take. One of the options is to extend the term, by doing this you reduce the monthly payments and therefore reduce the amount of is disposable income required to cover it. However, this will result in more interest, significantly more in fact, being paid over the whole term. Another option is to take a loan over 5 years as the calculation can sometimes favour this, largely because the rates are more stable and lenders don’t need to consider the variable rate you might go onto as much.

Nothing beats seeing it in action though. Lenders all have their own affordability calculators and they vary significantly in what questions they ask and what they prioritise. As a result the simpler your income and circumstances the more closely aligned they will be, and vice versa. Fortunately we are lucky to have several tools that aggregate this information so we can get a broad idea of where lenders stand for a given scenario. Consider the following examples:

A single applicant with no children and a basic salary income.

A couple where one is self employed, the other employed, with 2 children, some debts and benefits, overtime and other common variables. Looking at the charts you can see the latter has a significant difference between what each lender will offer, whereas the former is fairly consistent. The more variables you introduce, the more important its going to be to understand where you fall on the scale because some of the lenders that appear at the top of the table can be significantly more expensive…

 The number one question asked by clients is “how much can I borrow?” or “what house can I afford?”. The challenge as a broker is to understand all these variables, understand how important that max loan is related to the value of houses you’d be interested in and then balance that with both cost and other criteria possibly relating to employment, the property etc. We don’t want to give you the very highest figure and then find that when you find a house you only have choice of one or two lenders, nor do we want to sell you short and be too conservative because we might stop you getting a dream home. There’s never a simple answer!

Buy to Let Mortgage Affordability

Overview of How Affordability is Calculated for BTL

For buy-to-let mortgages, affordability is primarily calculated based on the expected rental income from the property. Lenders typically require that the annual rental income covers a stressed interest rate by a certain percentage, often 125% or 145%. This means that if interest rates rise, the rental income should still comfortably cover mortgage payments, providing a cushion for landlords to manage their properties sustainably.

Digging into this however reveals a much more complex set of factors. Firstly every lender has its own stressed rate and that can often depend on the product. Some have a different stress rate for each rate, some use the variable rate plus a margin, usually 1.5% to 2%, some will use the actual rate, i.e. not stressed, and others will have a specific rate they use not necessarily linked to the above. Again lenders use calculators to consider all of this and again we can see significant variance depending on the number of questions they ask.

The extra factor of 125% or 145% is there to account for both costs involved in maintaining a home, such as maintenance, void periods, service charges etc and tax. Where a client can demonstrate that they earn less than the higher rate including property revenue, then we can sometimes use 125%, otherwise its 145%. If the property is being bought within a limited company, because costs are deducted before taxes the old style 125% margin can be used and this is one of the principle benefits of buying with a limited company, you can generally borrow more for the same rent.

We cannot advise on tax matters and so you should always consult with a qualified tax advisor on whether a limited company structure is right or you.

To calculate the max loan take the interest only balance of the mortgage, and annualise the stressed interest. So for a £100,000 mortgage at 6.5% that’s £6500. Now apply the multipliers, £8125 or £9425, monthly that’s £677 or £785. The property would need to rent for this amount or more to qualify. The rental figure is set by the surveyor when they do the valuation and can sometimes be lower than the actual rent being charged if they feel that’s over the market rate. As a result lenders will generally always take the lower of the two.

Other Influencing Factors for BTL

Several factors can influence buy-to-let mortgage affordability. Agency fees and service charges associated with property management can affect net rental income. The choice between under 5-year and over 5-year mortgage deals can impact interest rates and repayment terms. Houses of multiple occupation are often factored slightly differently, with higher stressed rates and multipliers, sometimes as high as 8% currently and 160%. The combined rental of each room is used and this is generally so much more significant that its less of an issue at present.

Portfolio Lending

Where a client has more than 3 properties, excluding their residential, then lenders must consider them portfolio landlords and in addition to the above the whole portfolio must also pass a similar rule on aggregate. Not only is the calculation usually slightly more relaxed than the individual property, but if the properties were purchased whilst the same calculations were used, then its unlikely to affect the result. However, older properties with lower values or higher loans can cause some issues, and there are frequently some tother rules that govern this such as higher minimum incomes, from £35k to 75k, and a minimum loan to value, again on aggregate

Strategies to Maximize Borrowing Potential in BTL

To maximize borrowing potential for buy-to-let mortgages, landlords can consider top slicing, which involves using personal income to supplement rental income when calculating affordability. Hybrid ownership models, where the lender will consider the split of ownership are also available. If for instance a basic rate tax payer jointly owns a property with a higher rate tax payer, but on a 1:99 split as far as the HMRC or land registry is concerned, then lenders will adjust the multiples to suit, allowing more favourable borrowing.

Conclusion

Navigating mortgage affordability can be complex, with numerous factors to consider for both residential and buy-to-let properties. Understanding the calculations, regulations, and strategies involved is essential for maximizing your borrowing potential. While higher loan amounts can be attractive, it’s important to weigh the overall cost and choose a lender that offers the best combination of terms and rates. By carefully planning and considering all aspects of mortgage affordability, you can make informed decisions that support your financial objectives.

I hope that this highlights the benefits of speaking to a broker here at AALTO Mortgages, because there might be very cost effective ways of increasing your borrowing simply by knowing the important factors and being able to present them to you based on cost, efficiency, criteria and max loan.