may reduce the amount you can borrow. The same goes if you have lots of financial debt commitments – such as car finance, personal loans or credit-card debt that you don’t repay in full each month. As long as the debt is not judged excessive, though, it is the amount you are paying in monthly payments, and so reducing what is left to spend, that influences the amount you can borrow, not the outstanding debt. Debt with less than six months to run is usually ignored.
Student loans count only in so far as repaying them means you have less disposable income left in your bank account, which feeds into how much you can afford to borrow. The fact that you have student-loan ‘debt’ does not count against you.
Banks will also look to see how your income or affordability levels may change in future. This is why a former colleague of mine went to the bank to apply for a mortgage with a very baggy top on, and took good care to pay for any Mothercare purchases with cash. If they had known she was going to have a baby, she guessed they would have judged her on balance a greater risk, likely to see both a dip in her earnings and a rise in her outgoings, even though she was pretty confident she could afford a big mortgage just fine.
SIDENOTE It is illegal for a bank to discriminate against an applicant because she is pregnant, so, like a job interviewer, you cannot be asked: ‘Are you pregnant or do you plan to get pregnant?’ But most will have questions on their application forms like: ‘Do you anticipate any changes to your financial circumstances in the next three months which might make it difficult for you to make your mortgage payments?’
You need to be honest. Lying on the application form is fraud, though you do not have to disclose your pregnancy. It should, however, make you think hard about whether you can actually afford the mortgage you want if your income or circumstances change once you have got it. A bank can only know so much about your ability to repay in the future; it is up to you to gauge how much you want to stretch yourself, knowing what life or job changes lie ahead.
Earnings matter, if only to work out whether you stand a chance of buying
Before you start browsing Zoopla it is a good idea to work out roughly how much you are realistically going to be able to borrow based on your earnings. This is only part of the picture as explained above, but a good place to begin. There are lots of mortgage calculators online that work on this basis. The rough rule of thumb at the moment, though it varies between banks, is that you can borrow about four to four and a half times your pre-tax salary. Some lenders will stretch to five times your salary, as long as it is affordable (if you are self-employed this might not apply – more below). Clydesdale bank this year launched a ‘professional mortgage’ with a maximum loan 5.5 times salaries if you are a newly qualified professional such as a doctor, vet, solicitor or architect. This is called an ‘income multiple’. That means if you earn £35,000 a year before tax you are unlikely to be able to borrow more than about £158,000 if you are buying alone. Now you can see why there’s a housing-affordability problem.
It is worth noting that the income multiple is the same for couples as for single applicants, so you are in a much stronger position if you buy with another person. Banks also treat ‘non-guaranteed’ income differently – items like commission payments and bonuses. This means you might get quirks where one bank actually offers you a bigger mortgage on a four-times-income multiple than another bank which is prepared to lend on a four-and-a-half-times-income multiple but does not allow for bonuses.
The maximum income multiple also varies with what LTV you can afford. Someone with a 25 per cent deposit is more likely to be able to borrow five times their income, whereas if you have just 5 per cent deposit, the maximum is unlikely to be more than four times. This maximum may also vary according to how much you earn, on the basis that you can allocate a higher proportion of your income to the mortgage repayments if you are richer. As Mr Boulger puts it: ‘Someone earning £80,000 won’t spend four times as much on toilet rolls as someone earning £20,000.’
How to get a mortgage if you are self-employed
You used to be able to apply for ‘self-cert’ mortgages, nicknamed ‘liar loans’, which allowed you, as a self-employed worker, to state your income without any actual proof of it. These were banned in 2014. If you are self-employed or a freelancer you apply for mortgages in the same ways as everyone else, but it is now a lot harder to get one, though do not give up before you have tried.
Ideally you need at least two years of accounts, and three years will go down even better. Many banks want these signed off by an accountant. You also need to show the income you have reported in your self-assessment tax return to HMRC; you can download the SA302 form and tax-year overview from HMRC’s website.
Some lenders – for example, Halifax (if you have a great credit score), Newcastle Building Society, Kensington and Precise Mortgages – will consider those who have been self-employed for only a year. Smaller building societies tend to be a better bet: they are less likely to pull ‘Computer says no’. You may also find it easier if you were with the same business as a full-time employee before you started going freelance.
If your earnings have been rising, banks will usually take your average income for the past two or so years. If it has fallen, they will probably use the latest and lowest figure of earnings. The best thing to do is apply to a lender you know will be most happy to offer you a deal given your specific circumstances. A broker can help matchmake. If you are self-employed, take extra care with spending in the run-up to a mortgage application. You want to act especially frugally for at least six months beforehand.
What is ‘stress testing’ and why the future matters as much as the present
Post-credit-crunch lending rules now also require banks to make sure that a mortgage is affordable not only right now but also in the future. The result is ‘stress testing’. You may be able to comfortably meet mortgage repayments on your existing salary with current low interest rates, but what if interest rates rise? You will only be able to borrow as much as you can happily afford with an interest rate of 3 per cent higher than it is today, usually compared with a bank’s standard variable rate (more on what that is in a minute) at the point at which you apply. That means most first-time buyers are stress-tested on the basis of a mortgage that might fall payable with interest of 7 to 7.5 per cent.
This protects you from overstretching yourself, but also means you are limited with how great a risk you can take on borrowing, even if you feel confident that your earnings are going to increase significantly in the future.
What is your credit score and why does it matter?
When it assesses whether or not you can afford a mortgage, a bank will score your creditworthiness based on information it can gather from your credit history or credit file as well as your bank statements. Your credit history is a record of your interactions with other financial companies: banks, energy providers and so on, kept by credit-reference agencies. Your prospective lender is looking for evidence of past borrowing behaviour to assess whether or not you will be a well-behaved borrower going forward.
You are also judged on things like how long you have been with the same employer, how long you have lived at your address, and how long you have had your bank account.
Most banks, building societies and financial companies have their own arcane bespoke credit-scoring system, based on what factors they deem important as a yardstick of reliability. No one is quite sure how they all work, how they are compiled, and how banks use them.
