As of the 1st of August 2022, Bank of England have announced that they are scrapping the mortgage affordability test, which was designed to test whether house buyers would still be able to afford their property after an increase in interest rates or changed financial circumstances.
This decision can potentially make it easier for first-time buyers to get on the property ladder, however, does not mean that all affordability factors are taken out of consideration by lenders.
What is the mortgage affordability test?
The Mortgage Affordability test was introduced in 2014 as part of a wide-scale tightening up of the mortgage market, aiming to reduce the likelihood a repeat of the mis-selling scandal that played a role in the 2008 financial crisis. Also referred to as a ‘stress test’, it judged how well potential borrowers would be able to cope under additional financial pressure.
As much as the news have been met with positive reactions from aspiring homeowners, it’s worth remembering that the test was only designed to assess whether house buyers would have enough income to be able to pay their mortgage in changing circumstances, and does not mean that lenders will not be taking your general affordability into consideration during the mortgage application process.
The Mortgage Affordability test can also be compared to a forensic look at your personal finances - not only whether you have enough to pay your mortgage, but whether you will still be able to make regular repayments at a time of rising interest rates, or when experiencing other big setbacks in your finances such as losing your job.
Mortgage affordability test vs. Loan to Income
The mortgage affordability test is only one of many affordability assessments that an aspiring buyer will have to go through. As much as it can make the mortgage application process a little bit more lenient, buyers' accounts will still be carefully examined to establish their creditworthiness.
The Loan to income ratio, is one of the main calculations lenders rely on when determining your affordability. Loan to income ratio simply outlines the maximum mortgage value you are entitled to based on your income, and can normally be calculated by multiplying your annual income by multiples of 3.5 to 5, depending on the lender’s current criteria.
For example, some lenders may choose to only let people borrow 3.5 times the value of their annual income, in which case, if your salary is £30,000, you could potentially take out a mortgage valued at £105,000. You may find that other lenders may offer higher value mortgages, where they consider even up to 5 times your annual income, in which case with a £30,000 salary you could borrow up to £150,000.
This calculation is worth taking into account at the start of your house hunting journey to ensure you have a full awareness of your credit limits, and avoid disappointment may your chosen property cost more than your credit allowance.
If you are looking to purchase a property, a good starting point when trying to figure out your average loan value is to simply multiply your annual income by 4, which is the average loan to value ratio for most lenders. It’s worth noting that as much as this number may not be exactly the same as your final offer from the lender, it will give you an indication of roughly how much you could borrow.
Other factors taken into account when determining your affordability
The mortgage process is a lot more multi-dimensional than many house buyers may anticipate. Even with changes in regulations and criteria, what will truly determine your ability to get a mortgage is your creditworthiness. Creditworthiness can also be described as the extent to which a person is considered suitable to receive financial credit, and therefore defines how much of a risk a lender takes on when lending you money.
All types of loans come with uncertainty to the lender. It is therefore their responsibility to ensure that they reduce risk by having a strict list of criteria that a borrower must meet to get a mortgage. This is why first-time buyers are recommended to prepare adequately before attempting to make a purchase, by improving their credit score, clearing up any inconsistencies in their accounts, and saving up an adequate amount of money for their deposit.
You can find some of the main factors which are likely to affect your affordability below:
- Your salary - Your salary will be a key reference point when determining whether you can afford a home or not. Simply put, if the price of the home you wish to purchase does not meet the loan-to-value ratio, you will most likely have trouble getting a mortgage as the lender assumes you may not be able to make regular and consistent repayments.
- How long you’ve been in your job - Job security is very important when attempting to purchase a home. A stable employment history and recurring income suggest good financial stability and therefore improve your affordability. If you have been in a job for less than three months, and still in your probationary period, or if you are in a temporary position, lenders may be hesitant to offer you a mortgage.
- Whether you’re newly self-employed - The mortgage process is slightly different for those who are self-employed, as you may be required to submit up to three years’ worth of accounts instead of the usual three month’s worth of bank statements when employed by someone else. This is to ensure that your self-employed income remains consistent year on year, reassuring the lender of your ability to make mortgage repayments. If you have only recently opened your own business, and do not have at least one year's worth of accounts, you may struggle to get a mortgage due to insufficient financial history.
- Your credit score - Your credit score will affect your affordability as it gives lenders a snapshot of your creditworthiness. If your credit score is poor, due to missing previous credit card or loan payments, lenders will assume you either do not have enough recurring income to pay your mortgage without going into additional debt, or that you do not have the skills necessary to manage your finances effectively.
- Your spending habits - Lenders will be looking at your spending habits to assess your affordability. All of your outgoing bills, including things such as car payments, mobile phone payments and memberships will be taken into account to ensure you have enough money at the end of the month to pay your mortgage.
- Current or recent debt - Recently accumulated debt, such as credit card debt or loans, can suggest to the lender that you are experiencing financial issues and may not be able to commit to making regular mortgage repayments on time.
To find out more about your affordability, and the next steps you should take forward to purchase your next property, you can contact one of our experienced Mortgage Advisors for free.