Posted on 5 August 2014
Four months after the implementation of the Mortgage Market Review (MMR), copious amounts of articles and analysis have been written to educate, scare or confuse customers. The purpose of the review was to place safeguards in place and help the industry avoid the mistakes that were made in the past and to avoid a future market crash. The MMR did indeed help the market to sober up, but that will not happen overnight. Relying on past mortgage experiences can increase the difference between expectations and reality, given the more stringent lending criteria now in place.
The changes mean that there may be times when the lenders will not be able to help lending within our expectations. As human beings, we are not always prepared for a ‘no’ answer and so I have tried to help by summarising a number of key points, which the borrower needs to know but may not like to hear. Rejection is often the reason why many clients will skip from bank to bank in the hope that they will find a solution for their situation, ignoring in the process some fundamental mortgage rules.
Preparation is everything
The first step to mortgage success is to weigh up income and outgoings and calculate the maximum disposable or net income. The best policy is honesty and a borrower should check his bank and credit card statements for any regular and recurring expenditure. This should also include annual as well as quarterly expenses and after all costs of living have been deducted, you will have a net figure, which will give you the surplus income available to meet a new mortgage requirement. Do not include any rent or existing mortgages that are being settled. You will find that some of the expenses are for things we cannot live without such as payments for council tax, utility bills, telephone, transport costs and food. Others are discretionary such as subscriptions, holidays, clothes etc... The latter can also vary from month to month as they are seasonal, e.g. Christmas presents or summer holidays.
Then you will have to decide how much you are happy to spend on your new arrangement. Being realistic about how much you can afford without fundamentally changing your lifestyle is essential as it shows the lender a true reflection of your mortgage abilities. Deciding to reduce certain expenditure to accommodate a new mortgage payment will require discipline and routine and my advice will be to start as soon as you can. You will find that your decision affects the expenditure on discretionary items such as holidays, eating out, clothes etc... Imagine you are a home owner now, how would you feel if you had to spend less on these items? How easy is it to adjust to a new lifestyle?
Of course the final decision remains with the lenders but I will let you in on a little secret – banks do not like to see more than 40% of your disposable net income (income after taxes) going towards mortgage and debt repayments. Now you know why, sometimes, by extending the term of the mortgage and thereby reducing the monthly mortgage commitment, lenders can help you to borrow more.
Keep it real
In a few cases we are approached by clients whom we we may find it difficult to assist. For example, a client inherited £150,000 from her grandfather and wanted to purchase a property for £450,000 and in effect borrowing £300,000. Although she was investing a fairly large deposit, her employed earnings were only £28,000 which meant that she wanted to borrow more than 10 times her income. From her point of view by keeping control of her expenditure and extending the term of the mortgage to 35 years she believed she was able to meet the mortgage payments at the current very low rates. However, where affordability and rates are concerned, banks take a cautious approach and calculate if the mortgage is still affordable should the interest rates increase substantially. This stress testing is now crucial and in this instance the client failed the test. To safeguard affordability the banks will lend as a rule of thumb 3.5 to 4 times income with few able to exceed this limit on some occasions.
In the example above our client had also suggested that she might let out one of the rooms to a tenant to subsidise her income. Before she came to see us, she also spoke to another broker who had suggested that she applied for a buy-to-let mortgage.
A buy-to-let mortgage completely excludes any owner occupation and this advice is every bit as dangerous as it is criminal. Just because part of the property will be occupied by a lodger does not mean that a buy-to-let mortgage is the most appropriate answer. An easy solution is not always the right solution and if the client would like to invest in the property, she would have to let the whole house with no intention to live there at any time.
Interest only loans are another area where special attention is required. Many clients opt for an interest only option as the monthly payments are much lower due to the fact that capital is not being repaid. If you are purchasing as an investor, it may make sense to take an interest only loan if your reasons are speculative, i.e. investing for capital gains and not planning to keep the property. However, do think carefully about the reasons why you would like to invest. As many of my clients have come to realise, if they want to have an additional income in retirement, now is the time to take a buy to let mortgage on a repayment basis, so by the time they retire, they have a fully paid up and unencumbered income producing asset.
It is quite different if you are seeking an interest only option on your main home. Besides a dramatically reduced number of banks offering residential Interest Only mortgages, you will have to demonstrate that you are committed to a repayment strategy. A repayment strategy could be a pension plan releasing tax-free lump sum at retirement age, investment or shares, or sale of another property.
As always, John Charcol is here to help and we do hope the above will help you to get more ‘Yes’ answers and less ‘No’.
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