A Question of Multiples
Written on 5 February 2014 by
One of the first questions people ask us when they are embarking on a house purchase or re-mortgage is how much they can borrow.
I always give the same answer: it depends, which of course is not immediately helpful but let me explain.
In today’s mortgage realm every lender has its own rules and criteria and these can also vary depending on the loan amount you would like to borrow, the loan to value ratio (LTV), credit rating, affordability, debt to income ratio and... have I lost you?
Well, let me start with the most common and more familiar: income multiples. As a broad rule of thumb you can start with four times gross salary, although with more conservative lenders you may only be able to borrow three or three and a half times your gross income. However if you have a great credit score and a substantial deposit, you might be able to borrow up to five and a half times! This makes the answer to ‘how much can I borrow’ somewhat difficult to pin down. For example, if you are earning £25,000 the opportunities to borrow will range from £75,000 to £137,500 – a difference of over 80%! Common sense tells us that the more you wish to borrow, the more restricted your provider options will be.
If you’re self employed the lenders will need to see on average evidence of the last three years earnings. If you’re employed and your income includes bonuses, allowances or commission the calculation will be more complicated as lenders generally consider only a proportion of these. (We will look separately at the different types of income and how lenders consider them, so watch this space!)
Other lenders make decisions based on affordability. This is a basically the ability to maintain your mortgage payments from your disposable income. In this case the lenders will take your net, not gross income (in contrast to the rule of thumb for multiples) and will examine your expenses of daily living – fixed and discretionary. All super organised spreadsheet junkies can rejoice – for the rest of us you can download the John Charcol budget planner from here. The fixed expenses will be normally your utility bills, payments on debts, other mortgages, etc.... The discretionary expenses will be the ones you can control and they normally reflect lifestyle choices – food, gym, holidays, entertainment, regular savings, pensions and life insurance will be considered or not depending on the mortgage provider.
You have probably noted that I did say: net income. This is important as if you have significant deductions from your salary, pension deductions, salary sacrifice, child vouchers, employer’s loan repayments etc will reduce the amount of net salary and with that – the amount of loan you can borrow. With this in mind, you may notice that a lender working on income multiples may be able to lend more than a lender based on the affordability model.
Underlying the above is a debt to income ratio which is used to describe the amount of monthly mortgage payment as a proportion of the net monthly income. The banks can normally approve applications where the mortgage payment does not exceed 40% of the net income. How do the banks work this out? In practise, for someone who is on a salary of £45,000 and would like to borrow £200,000, the monthly mortgage payments at a rate of 3.5% will be £1,001 on a 25-year term. The net monthly income after tax and national insurance will be £2,755; hence the debt to income ratio will be £1,001/£2,755*100=36%. If the same client would like to borrow £200,000 for 10 years at the same rate of 3.5%, then the monthly payment will be £1,978 and the mortgage will be unaffordable under this calculation as the debt to income will be more than 40%: £1,978/£2,755*100=72%.
Confused? You’re not the only one.
Fortunately, help is always on the other end of the phone line and all John Charcol advisers are trained in depth to recognise the lenders’ policies and to choose the right mortgage for you.
- Salary: £45,000
- Mortgage: £200,000 over 25 years at 3.5%
- Monthly Mortgage repayment: £1,001
- Net Monthly Income after Deductions: £2,755
- Debt to Income Ratio: £1001.00/£2,755.00 * 100 = 36%
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