Mortgages: How much can I afford to borrow?
Life, after all, has a habit of changing - you might have kids and drop to one income, or set up your own business, for example.
There are a huge number of changes that could happen in your world that could affect your ability to meet your monthly mortgage repayments and that's before you even contemplate interest rate rises.
So as the housing market continues to grow from strength to strength, the Financial Conduct Authority is putting the responsibility on lenders to ensure they can afford the loan on offer.
Thanks to something known as the Mortgage Market Review they can now take a fine-tooth comb to your bank statements, quizzing you on everything from how much you spend on haircuts to childcare and gambling.
So before you even glance at the property pages you need to have a good idea of how much you can afford to borrow and if you are going to have to shell out more than are used to paying – either in mortgage or rent – you need to work out exactly how much extra you can take on.
"The best thing is to do a proper budget plan," explains Andrew Montlake, director of mortgage adviser Coreco. "Look at how much you have coming in and how much is going out."
Bills, food, travel and gym memberships are all easy expenses to remember but don't forget about all that money that goes on coffees, eating out, shopping and other treats. Then there are ad hoc expenses like holidays, renewing your insurance and car maintenance to work in. Go through old bank statements or keep a spending diary to get a better idea of how much you are spending and where.
He adds: "Look at what expenditure will stop and what will increase when you move."
Remember too that as you prepare to buy a new home, having a rainy day fund is more important than ever, so don't forget to factor saving into your budget.
If you don't have as much to play with as you thought, it may be that you can cut back on discretionary spending – eating out, gym memberships and so on – or you can look to reduce your household bills by switching to better deals. Don't get too carried away though, this isn't crash budgeting to pay for a holiday or other short-term goal, you need to be able to live with your new budget long term.
Montlake says: "We recommend that around three to six months before you plan to borrow you start to rein in your spending. If you are going down to zero in the bank every month it could be an issue with some lenders. You don't have to live like a monk – it's just about being sensible and presenting yourself in the best possible way."
Stuart Gregory, managing director of mortgage broker Lentune Mortgages, says this is also a good time to give up any financial vices. "Eliminate your use of betting firms and avoid payday lenders like the plague."
By the time you have completed this process you should have a reasonable idea of how much you can afford to pay in mortgage payments now and the process will put you in good stead for your lender's affordability assessment.
As David Hollingworth, head of communications at broker London & Country, says: "Doing a budget will help you answer questions you're going to be asked anyway by your lender."
During the assessment - which could last a number of hours – the lender will want to know exactly how much you have coming in and how much you have going out. It may ask for evidence to support your claims and is likely to want to see three months' worth of bank statements.
James Thorpe, spokesperson for HSBC, explains: "We are trying to understand and get a picture of your committed expenditure versus your discretionary expenditure and we'll be looking to see if you can make cutbacks if needed. If you are saving money that will stand you in the best stead."
Will childcare hinder your ability to borrow?
As part of the new rules, lenders will be taking a far greater interest in expenditure on pensions, any service charges that are payable on your property, and, in what could be very bad news for parents of young children: childcare. Hollingworth says this is one area where parents could really struggle and find themselves unable to borrow sums they would have previously been offered.
Historically lenders might have deduced that if you had kids you would have higher expenditure but they would not have specifically asked about your childcare costs. Now you can expect your lender to look at this area much more closely. "Childcare really has the potential to rock the amount you can borrow," he says. "It's a big cost that can really zap your income and previously lenders weren't really looking at the issue in much detail."
What about the future?
You (and your lender) don't just need to think about whether you can afford the mortgage payments now. You need to think about whether you'll be able to afford them in years to come. For example is there anything in the pipeline that could impact on your ability to repay your mortgage?
The biggy for many younger buyers will be if you plan to have kids. You may, if only for a while, drop down to one income, or face hefty childcare bills. Of course your spending in other areas will reduce (bye bye nights out and city breaks…), but you still need to be sure you will cope with an invariably tighter budget.
As part of this, lenders could legitimately ask couples if they are pregnant or planning to start a family soon. "If you are going to be on maternity leave it doesn't mean they won't lend to you," says Hollingworth, "but they may ask for more information about your plans."
Kids or no kids the other threat on the horizon is interest rates. Nobody expected rates to stay at rock bottom for so long, but they will start to rise at some point. Even if you go for a fixed-rate mortgage, it will only provide you with the peace of mind that your rates won't rise for a few years. And, when you do eventually remortgage, in a higher interest rate world your new loan will inevitably be more expensive than your current one.
For this reason lenders will also ‘stress test' your application – this means they don't just want to see if you can afford the mortgage at current rates, they want to see that you'll still be able to afford repayments when interest rates rise.
"Lenders will stress test every loan that isn't a five-year fix," says Montlake. "It generally works out around the 7% mark." This would see repayments on a £150,000 mortgage with a current pay rate of 2.7% soar from £688 a month to £1,060 - if the rate were ever to hit 7%.
Can you beat the rules?
How much you are affected by the new rules will very much depend on your circumstances. Montlake says: "Overall the same amount of people will probably be getting loans but some may not be able to borrow as much as they thought. Others, such as those with two incomes, with no kids and no debt may actually be able to borrow more."
However if you don't qualify for a mortgage or aren't able to borrow the full amount you need, it's important not to give up. Gregory says: "Any borrower must not get disheartened if they get a ‘no'." This is because different lenders will interpret the rules in different ways. "Some borrowers may fail with some lenders but pass with others."
This is one of a number of reasons why it may make sense to arrange your mortgage with a broker – however simple you think your application could be. If at first you don't succeed your adviser will be in the best position to get you an offer, saving you the hassle of approaching other lenders and going through numerous affordability assessments. "Going up and down the high street on your own could be a very lengthy process," warns Hollingworth.
Montlake also suggests there's more chance of your application being approved if you use a broker, amid concerns that lenders' own advisers – whom you may speak to in branch or over the phone - may be a little overzealous.
"Direct branch staff are new and have very strict guidelines to follow and this is where silly questions such as ‘how many lattes do you buy' come in? They are taking the rules very literally at the moment."
If you use a broker, however, the lender will rely on them to do affordability checks on their behalf and given that they are likely to be more experienced and have more expertise in this area, they're likely to be a bit more pragmatic.
Montlake explains: "Lenders delegate this to brokers and we're just doing what we've always done. Going through budget planners has always been part of the job. It's not in our interest to sell mortgages borrowers can't afford. We do turn people away," he adds.