When you apply for a mortgage, whether as a first-time buyer or moving house, one of the first things you’ll want to do is find out how much you can afford to borrow. An affordability assessment is the main factor in determining this.
Lenders use affordability assessment to work out how much money it safe to loan you, based on your income and outgoings.
By conducting an affordability assessment, the mortgage provider tries to make sure they are not lending more than you can afford to repay. This protects them from losing their money, and also protects you from losing your home.
How Do Mortgage Affordability Assessments Work
When you apply for a mortgage, the lender needs to see evidence of your income and outgoings to work out how much they are able to lend you.
Every mortgage provider has slightly different criteria and thresholds.
However, as a rule of thumb, most lenders need to see that your mortgage will not eat into more than 35% of your total monthly income and that the money you need to pay your mortgage is not already tied up in other expenses.
To work this out, the lender will carry out a series of tests.
Annual Pre-Tax Income
The first thing they will look at is your annual pre-tax income. Most lenders consider mortgages which are worth 3-4.5 times the value of your annual pre-tax income. You may be able to get more than this in exceptional circumstances, for example, if you earn a very high salary in reliable employment.
Lenders will require copies of your payslips and P60 if you are employed, or at least two years of accounts if you are self-employed to get a clear picture of your earnings.
The second part of the test concerns your outgoings. The lender needs to see how much you spend on a regular basis to work out whether your budget can accommodate your new mortgage.
Simply filling out a form is not enough- the lender will need to see evidence of your spending over a few months to assess your outgoings accurately. The easiest way for them to do this is to check your credit report for fixed debt expenditures and request copies of your bank statements.
Depending on how flexible your lender is, they may separate fixed outgoings (e.g. credit cards, child maintenance, energy bills) from non-essentials which are easier to cut back on when they assess your outgoings.
However, most lenders will use all of the information to glean a complete picture of how much you spend on a regular basis.
The Stress Test
After lenders have an accurate picture of your income, assets and expenditure, your application is subjected to a ‘stress test’. They will play with the numbers you have given them to see how easily you could continue paying your mortgage if your circumstances were to change. For example, they might try to test how your finances would cope given a period of unemployment or the birth child.
This is designed to give them a picture of how resilient your budget is and whether you could continue to repay your mortgage even if things became bumpy for a while.
Why Are Mortgage Affordability Assessments Important?
Affordability assessments are an important tool because they protect both parties from taking on risky debt, and they also determine how much you can afford to borrow.
Prior to 2014, the maximum size of your mortgage was decided on by multiplying your salary by four. However, this system was not ideal because it did not take into account the fixed outgoings that people already had.
This meant that it was possible to be granted a large mortgage with high monthly repayments if you had a good salary, even if you spent most of that income on paying off other debts.
As a result, it was very easy to be given a mortgage which you could not realistically afford to pay.
The new affordability tests take into account your expenses and also check your budget for resilience. This is important because it prevents you from borrowing too much, which could cause you to get into financial difficulty and lose your home.
The stricter assessment that lenders now use also forces mortgage applicants to confront their finances in detail before they come to apply for a mortgage.
Although this creates a lot of extra work, it helps people to consider their budget more carefully and forces them to consider their spending habits.
How to Prepare for a Mortgage Affordability Assessment Test
When you are subject to a lender’s affordability checks, you will need to provide evidence of your financial status.
To give your application the best chance, it is a good idea to consciously monitor your spending for several months before you plan to apply. This will help you work out how much you could be approved for and will let you see if there are any areas where you could make improvements to your budget.
Assess Your Current Spending
When you go through affordability checks, you will need to provide hard evidence of your spending habits, such as bank statements. It is, therefore, a good idea to look at your bank statements from recent months and check what you spend your money on.
Ideally, you should have some left at the end of the months and not be spending more than about 8% of your pre-tax salary on debt.
Adjust Your Current Spending
If you regularly run out of money towards the end of the month, have large debt expenditures or don’t hold any savings, you may need to make adjustments to your budget to improve your chances of passing an affordability check. Work out how much you spend on essentials and how much you spend on non-essentials.
If you could easily cut back a little on your non-essential spending, doing so is likely to improve your chances of passing an affordability check. If most of your income goes on essentials, think about whether there are ways you could reduce these.
It may be the case that your mortgage application needs to wait until you have cleared some debts to create room in your budget for a mortgage.
Stick to the Changes
Your lender may require several months’ bank statements as part of their checks, so you’ll need to stick with your new budget for long enough to show that it’s a habit.
It is also important to remember that the point of making changes is not to ‘cheat’ the test – affordability checks are there to protect you too, and by sticking to a more balanced budget, you are improving the affordability of your own mortgage.
If your budget feels unrealistic or stretched, then it may not be sustainable, and you should perhaps think about other changes you could make, such as borrowing less or delaying your application. At the same time, you take steps to improve your financial situation.
What if I’m Self-Employed?
Most lenders accept applications from self-employed people. However, they may require evidence of your income stretching back over a longer period of time.
Most providers ask for at least two years’ accounts to demonstrate your income.
However, every lender is different, and some may require longer or even allow you to apply with just one year’s accounts to show your income.
Are Both Incomes Considered on a Joint Application?
Yes. For a joint mortgage application, both people’s incomes and expenditures are combined. For this reason, you may be able to afford more as a pair than you would as a sole applicant.
If more than two people are applying for the mortgage, only the incomes and spending of up to two people in the group will be taken into consideration by the lender. It is up to the group to decide whose accounts they would like to submit for the assessment.
Is My Overtime or Bonus Included in a Mortgage Affordability Assessment?
For employees who work in certain industries, overtime and bonuses can constitute a substantial portion of your income. However, due to the fact that your employment contract does not guarantee them, most lenders will only take into account a percentage of your total income derived from bonuses and overtime.
Commonly, bonus and overtime income is capped at 50%, although the cap may vary from lender to lender. For example, a salaried income of £30,000 with an annual £5000 bonus, would be considered as a total income of £32,500- taking just half of the bonus into account.
Every lender has slightly different rules regarding this, so it is important to discuss this with them before you application to make sure you understand how your income will be calculated.
What Happens if I Fail a Mortgage Affordability Assessment?
There are many reasons you could fail an affordability assessment, but all of them lead back to the fact that the lender does not believe you could comfortably afford the mortgage you asked for.
Common reasons that people fail affordability checks include:
- Having a low income
- Having lots of fixed outgoings
- Having many other debts
- Having income which the lender won’t take into account (e.g. overtime)
If you are rejected, you can choose to look for a lender with different criteria, ask for a smaller mortgage or you may decide the best thing to do is make adjustments to your spending and budget in order to improve your financial situation.
Although rejection can be disheartening and frustration, it is important to remember that affordability checks are not just in place to protect the lender- they are there to protect you, too.
How Can The Mortgage Bank Help?
Here at The Mortgage Bank, we have partnered with some of the UK’s leading mortgage brokers.
They have already helped thousands of people get the best mortgage deal even people that have been refused before, and they can do the same for you.
Choosing an independent adviser means they won’t recommend a scheme unless they are sure it is in your best interests. Their advice is also regulated by the FCA, which gives you an additional layer of protection.
If you would like to speak to one of these brokers who can provide you with a ‘whole market quote’ then click on the below and answer the very simple questions.