At a time of rising house prices and fierce competition in the mortgage market, Julia Harris Mortgage Analyst at moneyfacts.co.uk has evaluated the alternative methods used to assess affordability.
“Recent figures from the Council of Mortgage Lenders (CML) showed average first-time buyers borrowed 3.24 times their income - the highest level ever recorded. To facilitate this increased borrowing commitment, lenders are edging away from standard income multiples toward affordability models or more complex income multiples.
Affordability
“Research by Moneyfacts found five of the top 10 mortgage lenders now use ‘ability to repay’ in preference to income multiples in determining the amount they are prepared to lend.
“In an ‘ability to repay’ application, each case will be individually approved by way of an income and expenditure assessment, taking account of existing credit agreements, mortgage payments and contractual commitments. Many lenders will calculate a debt income ratio, which as a rule of thumb should not exceed 40%.
“However, it should not be forgotten that affordability is taken account of in all applications, the difference being this may come at a later stage in the application process, normally at agreement in principle.
“As affordability models are based on a score card principle, each lender will use a slightly different criteria, which could vary dependent on their current attitude to risk. With this unknown formula, the market becomes less transparent for the consumer, IFA or broker.
“This can in turn lead to borrowers completing a credit application on initial enquiry, which may in turn be declined. And every time this happens a footprint remains on their credit record, not a practice that should be encouraged.
“The advantage, on the other hand, is for those with a A1 credit record and free of outstanding debts who may find their maximum borrowing limits increased. A simple method for lenders to advance more without the scrutiny of irresponsible lending they face when raising multiples.
New style and enhanced income multiples
“Although many lenders still use income multiples, they are becoming much more sophisticated. Over 60 lenders have both their standard income multiples, plus a set of enhanced multiples. These will offer higher multiples for those on larger salaries, borrowing at a lower LTV or in a professional occupation.
“Even standard multiples now reflect risk and affordability. Take for example National Counties, whose multiples will be determined by the term of the mortgage. An applicant earning £25K on a 10 year term could borrow £66,750 at a multiple of 2.67 and over 25 years £91,750 at 3.67 times salary.
“Northern Rock on the other hand, will vary its standard income multiples based on credit score and the product chosen. For the same applicant, choosing a Together 5 year fixed rate product, they could borrow £125K, five times their salary.
“The majority of lenders will now also consider cases of more than two applicants, mostly allowing up to four borrowers. But don’t assume that all four salaries are taken into account. While some lenders will allow this, the income multiple may be lower, and others will only take account of the two highest salaries.
Survey
“Using a scenario of a single first-time buyer earning £25K, with no outstanding other debts and having saved a deposit of 10%, we decided to compare the use of income multiples and affordability calculators.
“The first point to make here is that the majority of the websites asked for far fewer details than we anticipated. Halifax, RBS and HSBC who claim to use an affordability model, simply asked for basic salary details with no reference to credit commitments.
“Alliance & Leicester and Nationwide, on the other hand, asked a lot more, including details of outstanding debts, amount of deposit and also in one case the postcode. So as with income multiples, the consumer should not rely on this as the amount they can borrow, as the picture could look very different after a full credit score assessment.
“Interestingly there is no clear pattern at this stage whether affordability or income multiples should offer the highest borrowing. But at the outset when completing your initial investigations, using computer driven affordability calculators with no clear process of how limits are worked out makes it difficult to know whom to approach.
“Whether it be through the use of income multiples, or affordability models, lenders using a more sophisticated and individually tailored approach, rather than a ‘one size fits all’, should be welcomed.”
