How much can I borrow with a mortgage?
If you’re thinking about buying a home, one of the first things you’ll want to work out is your budget. And if you’re buying with a mortgage, you’ll also want to work out how much you’ll feel comfortable repaying on a loan each month.
But your sums might not always match up with how much a lender will lend to you. This is because lenders have their own processes in place to determine your affordability.
Different lenders have their own policies around this, and the framework they work within is set by a regulator – in this instance, the Financial Conduct Authority. This is to ensure that the individual circumstance of every applicant is taken into account when determining if a mortgage repayment is affordable now, and will continue to be if things change, for example, if interest rates rise.
Rightmove’s mortgage expert Matt Smith says: “Figuring out how much you can borrow from a lender isn’t easy. Using tools like a Mortgage in Principle to get a personalised decision based on your individual circumstances is a really great way to get an answer. But you still may not fully understand how the lender came to their decision. This can be frustrating and confusing, as the amount may be very different to what you’re expecting and could be less than you’re already paying on rent or your current mortgage.”
“It’s really helpful to understand how lenders assess affordability before you apply for a mortgage loan, and the impact that things like existing credit payments will have on how much you can borrow,” he adds.
Here’s our guide to the things a lender takes into account when determining how much you can borrow.
How many times my salary can I borrow with a mortgage?
Your income forms the basis of how much you can borrow. Generally, the maximum loan amount is capped at a multiple of around 4.5 times your income. There are exceptions to this, and the cap can be higher, but this can depend on a range of factors, the main one being how much you earn.
What if I’m self-employed or earn commission?
If you have variable income, such as bonuses, overtime or commission payments, most lenders will take a proportion of this into account, but they won’t take the full amount into consideration when working out how much they’ll lend to you.
For example, if you have an annual bonus, some lenders may take an average of your bonuses over a two-year period, but others might only take half of this variable income into account.
If you’re a freelancer, self-employed, or work ad-hoc hours, such as a zero hours contract, lenders will usually look at an average of your income over a period of time. These policies aren’t consistent between different lenders, so if you have complex or uncertain income, it’s a good idea to speak to a mortgage broker who can help to find the best lender for you.
Lenders’ online tools – specifically a Mortgage in Principle – can also help you get an understanding of what you can borrow from each lender.
What happens if my mortgage term goes into retirement?
If your mortgage term goes beyond the age you think you’ll retire, your lender is likely to ask you questions about your income in retirement. They’ll want to know that you can continue to make your mortgage payments when you’re no longer working.
Therefore, choosing a term that will take your mortgage into your planned retirement may impact both the questions that lenders ask you, and specifically, the amount that you can borrow if you’re close to your retirement age.
You can read more about mortgage terms here.
Lenders will ask you for proof of your income
Lenders will expect you to verify your income by providing various documents, such as pay slips and self-assessment tax returns. This is a key part of the process, and if the amount you earn on your payslip or tax return is different to what you have disclosed in your application, it can mean that the lender will change the amount you can borrow. So, it’s important to make sure you get this right.
Finally, while most lenders will ask you for your income before tax (or gross income), they’ll take off tax and National Insurance contributions as part of their affordability assessment.
How do lenders assess how much you can afford to repay each month?
The amount that you earn forms the basis for lenders to determine how much you’ll have left each month to pay towards your mortgage. The following costs are then taken off and will have an impact on the amount a lender will lend to you.
Your existing credit commitments, such as credit cards, personal loans and car loans
Any payments to credit commitments you have will be taken off the amount you’ll be able pay to your mortgage each month, unless it is repaid before your mortgage starts.
Lenders will usually ask you about this in their application form, but they’ll also check credit reference agencies to verify your personal circumstances.
When it comes to credit or store cards, the lender is likely to ask if you repay balances in full every month or if you have balances outstanding. As with existing credit commitments, ongoing payments to credit/store cards will also be taken into account and could impact the amount they’re prepared to lend you.
Your household living costs
Lenders will then consider the day-to-day costs of running your home, as well as your lifestyle costs.
Most lenders use ‘modelled data’ to determine most of your day-to-day expenditure. This generally comes from data sources such as the Office of National Statistics (ONS) and the Consumer Price Index (CPI). This is a common measure of inflation, which tracks the price change over time for a basket of goods and services.
The ‘CPI market basket’ is sourced from expenditure information provided by families and individuals of what they’ve purchased. Lenders will also look at inflationary pressures on your expenditure and will take this into account.
This ‘basket’ is then used to estimate your living costs, and the cost of running your household. This can include things like mobile phone and broadband bills, TV subscriptions and day-to-day social activities.
Perhaps the most important factor in determining your household cost is the number of people living in your house. Because this takes into account day-to-day living costs, a home with two people will of course cost less than a home with four people living in it.
Other costs that are individual to you
Next, a lender will ask you questions about your expenditure that will be very specific to your individual circumstances (or the property you’re buying), such as council tax and commuting costs. If you aren’t sure of the specific details of these, lenders will ask you to provide an estimate.
A lender will also ask you to confirm any costs you’ll continually be committed to. These are costs that only some people will have, such as school fees or childcare.
Your future circumstances
Finally, lenders will ask you some questions you might think are a bit odd. They’ll want to know if you expect your expenditure to increase, or your income to reduce. Lenders will ask you this so they can take any changes to your future circumstances into account when assessing mortgage affordability.
Now a lender can determine how much income you could put towards a mortgage
The outcome of the processes above, which assess your income minus credit commitments, household expenditure, other costs and your future circumstances, will determine how much of your income will be available to support a mortgage.
For example, if you and your partner have a household income of £60,000 before tax, and you have some credit commitments, like a car loan or a credit card, these will be subtracted from your income, along with your living costs and other expenditure. See below:
|Working out how much income you could put towards a mortgage|
|Example: Monthly Household Income (after tax)||£3,600|
|Basic Living Costs||-£900|
|Income you could put towards a mortgage||£1,500|
So, you could work out your own rough estimate of the income you could put towards your mortgage, based on your individual circumstances, even before you apply for a mortgage. You’ll then also have your estimates ready for when you start the application process or get a Mortgage in Principle.
But there’s another process still to be applied by the lender to work out how much you can afford to borrow, which is called a ‘stressed rate’.
How a lender’s affordability assessment works
Since the financial crisis in 2008, the UK has reformed the regulation of its financial system to enhance stability, mitigate risks and to safeguard consumers.
This is why a lender needs to assess the amount you’ve asked to borrow to determine if that’s an affordable amount for you. They’ll also then add a higher rate, which is known as a ‘stressed rate’, to take into account potential increases in interest rates.
The stressed rate is usually between 1% and 2% above what they think their Standard Variable Rate (SVR) could rise to in the next five years. An SVR is a rate that you automatically move onto after your fixed rate deal has ended – the SVR is usually set by the lender and tends to be higher than fixed or tracker rate deals. The exact stressed rate lenders use isn’t usually published.
How is a stressed rate applied to your mortgage application?
Here’s an example based on the income calculation in the previous table.
Say that you and your partner are applying for a mortgage of £210,000 over a 25-year term, and you work out that the income you could put towards your mortgage is £1,500 a month. You check the latest rates and you’ve worked out that you can comfortably afford the 5.5% fixed rate which comes in at £1,290 payment a month.
This is the stage that you might find frustrating, as if you apply for a Mortgage in Principle on these terms, you could find that a lender won’t approve the amount you have worked out that you can afford. That’s because the lender will assess your affordability using the stressed rate.
So, while you’ve done your sums against an interest rate of 5.5%, the lender will actually check to see if you can afford a monthly payment when rates are about 8%, meaning that the minimum amount of income you need to put towards your mortgage is just above £1,600 a month. Because this would exceed your available monthly income of £1,500, the lender is likely to say you need to change the amount you’re asking to borrow, or to consider extending your mortgage term.
This is so they can be sure that you’ll be able to afford to make the repayments with the stressed rate applied. See example below.
How a stressed rate is applied by lenders to determine how much you can borrow
This example is based on a mortgage loan of £210,000 over 25-years at 5.5% interest
|Disposable Household Income||£1,500|
|Monthly mortgage repayment (5.5% interest)||£1,290|
|Stressed mortgage payment (8%)||£1,621|
|Stressed mortgage payment at 8% if mortgage term extends to 34 years||£1,500|
|Stressed mortgage payment at 8% if amount borrowed reduces to £194,000||£1,497|
You can read more about mortgage terms and how these can impact how much you can borrow here.
So, how does a lender work out how much they will loan to you?
To determine how much you can borrow, a lender will assess how much income you can put towards your mortgage by taking your credit commitments, household expenditure and any other costs into account. The income that is left over must then be greater than a stressed mortgage payment.
Our mortgage expert Matt Smith says: “That’s why there can sometimes be a difference between the mortgage repayments you’d be prepared to pay, compared to the stress-tested amount that the lender uses to determine affordability.“
“Mortgage affordability assessments are detailed, and can be complicated, so by taking people through each stage of the process, hopefully this will help those saving up for a deposit on their first home, or moving to their next home, to get a better understanding of what they can do to get the mortgage they want,” he adds.