What is affordability? All about creditworthiness in the UK

Affordability is one of the key factors in how much you can borrow for a mortgage. This article explains what affordability is, how lenders assess it, which types of income count towards it and what you can do to improve it.

What is affordability?

Affordability is a lender’s assessment of whether you can keep up the mortgage repayments, now and if interest rates rise, based on your income and your committed and essential spending. It largely decides how much a lender will let you borrow. The FCA does not set a maximum income multiple, but its rules require lenders to check that a mortgage is affordable, including testing whether you could still pay if interest rates rose. The Bank of England also limits how many new mortgages lenders can make at 4.5 times income or more. Within these rules, each lender sets its own criteria. To get a rough idea of your own figures, you can use the MoneyHelper mortgage affordability calculator.

Because affordability is about your ability to keep up the payments, the mortgage instalment cannot take up too large a share of your earnings. The exact figures depend on the statistical cost of living in your area and an analysis of the borrower’s expenses, but one thing is certain - it is very difficult to get a mortgage whose instalment will be 80% of your monthly budget.

How much is my affordability?

There is no single legal maximum. Bank of England rules limit how many new mortgages lenders can make at 4.5 times income or more, so borrowing above that level is less widely available and depends on the lender’s criteria.

Some lenders also apply different criteria to applicants with higher incomes.

Your age can affect the longest mortgage term a lender will offer, especially if the term would run into retirement. A shorter term means higher monthly payments, which can reduce how much you can borrow.

In practice, the income multiple a lender offers depends on its criteria and your circumstances.

Which types of income count towards affordability?

It is important to remember that banks differentiate between sources of income and the actual affordability may be much lower or higher than it appears. Below are some of the most common types of income and how lenders may look at them.

Working on a permanent basis

If you earn a salary from a permanent job, the income multiple a lender offers depends on its criteria and your circumstances, including any other financial commitments you have. Lenders may ask for evidence such as payslips.

Income from overtime and self-employment

Some lenders may consider income from overtime, bonuses and self-employment less stable than a basic salary. How lenders treat this income varies between lenders.

Lenders may ask for evidence such as payslips for overtime and bonuses, or accounts or tax calculations if you are self-employed.

Dividends

Dividend income can also be taken into account, but how lenders treat it varies between lenders and can depend on where the dividends come from - for example, whether you receive them as a director of your own limited company or from investments.

Lenders may ask for evidence such as company accounts or tax calculations.

Stipends

Whether stipend income counts towards your affordability, and how, varies between lenders. A lender may ask for evidence such as an award letter showing how much you receive and for how long.

What can you do to improve your affordability?

Whether you are getting a Decision in Principle or applying in full, give accurate information. Lenders check your income and spending when you make the full mortgage application, and deliberately giving false information on a mortgage application can be fraud. There are, however, a few legitimate ways to improve your affordability.

Pay rise or change to a better paid job

It’s obvious - if you earn more, your affordability will increase. Lenders generally see a higher basic salary as more reliable than overtime, and some lenders may use only part of your overtime income. In the first instance, therefore, you should consider whether it is possible to increase your base salary even a little.

Overtime income

Bearing in mind that overtime income can also increase your affordability, depending on the lender, consider whether you are able to work a few more hours a week. This is obviously not the best solution, but you may be able to borrow a few or even several thousand pounds more this way.

However, the bank may not accept all of your income if you turn out to be working, say, 80 hours a week - this is simply not sustainable in the long term, and after all, a mortgage is a long-term commitment.

Paying off loans and credit cards

Existing credit commitments such as credit cards, loans, phone contracts and car finance count as committed spending in a lender’s affordability assessment, so they can reduce how much you can borrow.

Paying off some of these commitments before you apply reduces your committed spending, but how much more you could borrow as a result depends on the lender’s assessment. Before you repay a loan early, check whether early repayment charges apply, and bear in mind that using savings to clear debt can reduce your deposit.

Reducing expenditure

You are not able to avoid spending on groceries, electricity, water or transport. However, you’ll often find that unnecessary or ill-advised subscriptions, expensive services and luxury products are really taking away a lot of money that you could be putting aside or putting towards paying off your own home. Before you apply for a mortgage, try to analyse your spending and check whether there is anything you could give up while maintaining your current living comfort.

How is it possible that I will have to reduce my spending?

Sometimes our clients wonder why the bank is reluctant to agree to give them a mortgage with an instalment that is similar to the rent they currently pay for their rented house or flat. The answer is extremely simple - it’s about risk.

Some people pay a disproportionate share of their earnings for rent, and rent can be similar to, or higher than, a mortgage payment for a comparable property. However, if interest rates were to rise sharply now, the situation could reverse, which would pose a real problem for the bank. For this reason, mortgage instalments cannot be too high. Renting is not regulated by the FCA in the way mortgage lending is, so a landlord does not have to apply the FCA’s mortgage affordability rules, although landlords and letting agents may carry out their own referencing checks.