Borrowing to buy a house based solely on your salary will be a thing of the past a report by Alliance & Leicester predicts.
The A&L study, undertaken by the Centre for Economics and Business Research, analyses the use of income multiples and examines how homeowners are likely to be affected by the use of affordability based lending criteria.
Affordability signals a more sophisticated and responsible lending approach based on an individual’s disposable income and personal circumstances, whereas income multiples look purely at gross salary.
The findings show that there has been a rise in the levels of disposable income, meaning that people may have more income available for mortgage repayments.
Affordability looks at an individual borrower’s circumstances. The report looked at a number of different household types, both single and dual income households and those with and without children. Using the average income and expenditure for each household type it compared the maximum mortgage lending under income multiples and typical affordability calculations.
Stephen Leonard, director of mortgages at Alliance & Leicester, says: “Affordability provides a more responsible approach to lending as it considers an applicant’s individual circumstances, those who are debt free will benefit the most.
“Lenders have responded to changing circumstances. The move towards affordability based lending means that more people will get a helping hand onto the property ladder, and homeowners will continue to be able to move up as their incomes rise.”
Some of the key findings were that, income multiples are a clumsy way of assessing the level of mortgage payments that people can afford, couples with two incomes, both those with and without children, are likely to be the biggest beneficiaries of an affordability based approach.
The report also found that, based on average incomes, most types of household could potentially afford to put a higher proportion of income towards their mortgage payments than income multiples would give them.
Affordability, although potentially offering higher maximum levels of borrowing to certain customers, is lower risk because it is based on a more accurate picture of the customer’s circumstances.
Affordability takes into account the different levels of essential spending on items including food, bills and transport that different types of household incur, whereas income multiples do not.
Interest rates have fallen steadily and have become less volatile than in the past. This encourages borrowing but doesn’t necessarily take account of affordability.
As income increases, there is a tipping point when an affordability based approach will start to offer larger mortgages than a simple income multiple approach. Affordability takes into account other individual factors including the level of household debt.
For example, a first time buyer with an income of 30,000 and no outstanding debt with a 10,000 deposit could borrow a maximum of 147,000 under an affordability based model. However a first time buyer with the same income and deposit, but with 3,000 in credit card debts and 200 in loan payments, could only borrow a maximum of 101,000, 46,000 less.
The report estimated the borrowing capacity of six different groups based on an analysis of affordability. In general an affordability based approach will allow higher income households to borrow more, especially those with dual incomes.