Mortgages: how much could you afford to borrow?

When you’re embarking on a property search, working out how much you can afford to borrow on a mortgage should be your first port of call.

Unless you’re in the fortunate position of being a wealthy cash buyer, your spending limits will determine not only what sort of property you can afford, but also its location. This article explains the nuts and bolts of mortgage affordability.

How much can you borrow?

The size of mortgage you can get depends on how much you earn, save, and spend.

Any savings, or other cash you’ve accrued, that can be directed towards a property purchase is known as a deposit. The amount of property already owned by an existing homeowner (‘the equity’), can also count towards a deposit the next time he/she moves house.

To secure a mortgage, whether you’re a first-time buyer or experienced home owner, most lenders require would-be borrowers to put up at least a small deposit. Say, 5% of the purchase price.

Size of loan

The amount you borrow compared to a property’s value is known as the loan-to-value, or LTV for short. This figure is expressed as a percentage. A deposit worth 10% would require a borrower to take out a mortgage with a 90% LTV for the property deal to proceed.

The larger the deposit a buyer can put up, the more flexibility and the better the interest rates lenders such as banks and building societies are likely to offer.

A question of income

When it comes to earnings, lenders use an ‘income multiple’ to make their loan calculations. They add up the total combined salary of applicants, and multiply it by a certain number to produce a maximum mortgage figure.

An income multiple of up to 4.5 times total salary is the norm. For example, a couple with a combined household income of £80,000 could potentially borrow £360,000.

But this is more of a rule-of-thumb than an absolute rule, because different mortgage lenders will offer varying amounts by way of a loan.

In terms of proving their income, self-employed workers face a bigger challenge because their employment status is regarded as less secure.

If you work for yourself, a lender may ask for proof of income stretching back three years. Details of your self-assessment arrangements for tax purposes are also required, along with an SA302 document. The latter relates to evidence of earnings as provided by HM Revenue & Customs.

Day-to-day spending

Even with a generous income multiple and a decent deposit, the amount you can borrow will be further determined by your spending habits and any outstanding debts. In other words, what’s realistically available each month to put towards a mortgage repayment.

This is called an affordability check, and it can shrink or inflate your borrowing, depending on how strict the lender’s check is.

Would-be mortgage applicants need to provide a history of bank account statements, showing how they spend their money. This clarifies to the lender whether potential borrowers can afford mortgage repayments in accordance with the lifestyle they keep.

It includes looking at how much you spend on monthly bills, including energy, broadband and mobile phone, as well as other regular outgoings such as transport and childcare. You might, in addition, be asked how much you spend on holidays and meals out.

Lenders also have to apply what is known as a ‘stress test’. This checks a customer’s financial resilience and looks at, not only what borrowers can afford now, but also what would happen if economic conditions turned against them in the future. For example, if their mortgage repayments were to rise thanks to an increase in interest rates.

Stamp duty and legal fees

People sometimes forget the impact of stamp duty and legal fees when they start house hunting. It’s crucial these are factored into calculations because bills can run into thousands of pounds, potentially putting a dent in a deposit and, therefore, affecting how much you can borrow.

Stamp duty works differently in each of the devolved nations, but is essentially linked to the purchase price of the property in question. In England it is called Stamp Duty Land Tax, whereas in Wales it’s referred to as Land Transaction Tax.

Payment of the tax is due, unless the value of the transaction falls within a so-called ‘nil-rate’ band. At the time of writing, slightly different stamp duty rules apply for first-time buyers compared with owners already on the property ladder.

With house prices so much higher in London and the South East compared to the rest of the UK, buyers in this area often face a higher stamp duty bracket. Find out how much you might need to pay using the Stamp Duty Land Tax calculator.

What to do next?

Preparation is key and for help in doing that you can call on the services of a mortgage broker.

They can guide you through affordability checks, the lending criteria of various banks and building societies, and the types of mortgages available. Some brokers charge for their services, while others are fee-free and take a commission from lenders instead. Ask about the fee model a broker uses at the outset of any meeting.

To get a feel for what is possible, use an online mortgage calculator. Most lenders have one on their websites. Just because you can borrow a big sum of money, it doesn’t always mean that you should.

Credit checks

It is also a good idea for all would-be borrowers to check their credit reports in advance of a mortgage application. Every adult with a history of borrowing has a credit file, which is referred to by lenders to judge whether or not you are a safe bet for a home loan. Use a credit reference agency to access your file, such as Experian, Equifax or TransUnion.

As you then inch closer to house hunting, consider getting a ‘mortgage in principle’, also referred to as an ‘agreement in principle’. This is where you give a lender a more detailed picture of your finances. In return, you’ll receive some idea of how much you can borrow.

It doesn’t guarantee you the deal, but gives you the reasonable expectation of securing a mortgage that size. Ultimately, the aim for would-be borrowers is to save, budget, and, where necessary, seek advice from the experts.