Double your mortgage in minutes
A new method to calculate how much a home-buyer can borrow has winners and losers, writes Stephen Pritchard
Wednesday 19 October 2005
This is what a growing number of banks are now willing to do thanks to a new way of calculating how much a home-buyer can borrow. Instead of using the salary multiples that mortgage companies have relied on for decades, lenders are increasingly using a system known as affordability-based lending. The potential benefits - for some buyers, at least - are significant.
Alliance & Leicester announced that it would move from salary multiples to affordability last week. The bank commissioned the Centre for Economics and Business Research (CEBR) to study the differences between affordability and conventional salary multiples. The full research is being kept private, but the bank has issued some key findings, which make for interesting reading. Based on average incomes, average house prices - around £155,000 - and a nominal mortgage rate of 6.5 per cent, a single person without children could borrow £124,316, up some £23,500 from the four-times salary multiple used by most banks and building societies.
Craig Calder, senior product manager at Alliance & Leicester, says that the difference could be enough to help hard-pressed, first-time buyers on to the property ladder. And although borrowing more could entail a greater risk, Calder argues that affordability-based lending is more responsible than using simple salary multiples. Fixed outgoings, from loan repayments to the costs of raising children, are taken into account, and mortgage offers more closely match individuals' circumstances. "We are not in the market for risky lending and believe this is the way to go," he says.
The changes also mean that the bank can allow for the fact that people in areas of expensive housing, such as London and the South-east, will be prepared to sacrifice other spending in order to cover the mortgage. And although some living costs will be higher in dearer areas, not all costs track house prices so closely. As people in London and the South-east tend to earn more than those in other parts of the UK, they also have more money to spend on the mortgage.
Some buyers, though, will lose out under affordability. Chief among these, CEBR found, are single parents. Once their outgoings are taken into account, they will be able to borrow almost £13,000 less. But a couple with children and one income will be better off.
Other losers will be those with significant debts, including recent graduates. Alliance & Leicester takes debt repayments into account when it calculates mortgage cover. This even applies to interest-free loans - someone with loan repayments of £200 a month and a credit card debt of £3,000 would be able to borrow £46,000 less.
The greatest beneficiaries, on the other hand, are dual-income households. Arguably these - especially double-income, no-kids families - have suffered most from the arbitrary nature of salary-based lending. The CEBR research assumed a four-times salary multiple for single-buyers and a three-times multiple for joint applicants, and some lenders are even more conservative than that. Yet many of a household's costs are fairly fixed, regardless of whether there are one or two wage-earners.
A two-income couple without children, on average incomes, could borrow an extra £109,000; a couple with children could borrow £91,500 more. But just because a lender will offer a larger mortgage does not mean it is always a good idea to take it up. Buyers might want to keep their mortgage under the threshold for mortgage indemnity premiums, or where higher interest rates kick in. This is generally for loans of 90 per cent or more of the house.
And, as Anna Bowes of financial advisers Chase de Vere cautions, maximum lending limits are just that - a cautious home-buyer might want to allow some headroom for interest rate increases or other unpredictable costs. "Buyers have to be honest with themselves, as well as with the lender, about what they can afford," she says.
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