We all know that in recent years, more lenders have moved from crude income multiples to more sophisticated affordability calculators in assessing what clients can borrow.
But are they really more sophisticated? Let’s take two different households and drive them through the two models and see where we end up.
The first is a household of three, with a single income of £20,000 per annum, the main earner in their mid-40s and a house they bought 15 years ago now worth £150,000.
The second is a young couple, earning £40,000 a year between them, in a trendy inner-city flat worth £225,000.
Under a crude income multiple model of 3.5 x single salary and 3 x joint the borrowing capacity of our first household is £75,000 and that of the young couple is £140,000 – simple and transparent.
But our sophisticated affordability calculator model says that the first household, with dependents and only one earner, has much less disposable income to fund ongoing mortgage payments than the young couple.
So using a formula that is largely secret, a lender such as NatWest says the first household can borrow only a meagre £53,683 and the young couple can borrow a whopping £190,000 because the calculator is more sophisticated and fair than the crude income multipliers. Is it?
If the events of the past three years are to teach us anything, surely what is most important is not just consumers’ immediate ability to service payments on any given debt, but the sheer scale of the debt households have taken on.
In our two households which of them, in the medium to long term, is realistically going to be able to get their mortgage paid off?
With future salary increments and chipping away at the debt, or maybe a small end of year bonus or future downsizing, which of the two is more likely to make an impact on their debt levels?
The sheer enormity of the £190,000 debt and low equity of the young couple tells me theirs is a tall order indeed. To my mind the low income household would have a manageable debt level, even if it were in excess of the £53,683 the affordability calculator allowed.
And what about the impact of future interest rate rises in the medium term? Which of the two is going to find themselves more able to cope?
The scale of the debt that affordability calculators allow for some favoured borrowers compared with crude income multipliers makes me wince at the thought.
If we look at the real world and learn some lessons from it, I have to conclude that what is most important is not the immediate ability to pay a mortgage but the sheer scale of the debt burden being taken on.
Long may those lenders that still offer income multiples, such as Leeds Building Society, continue to do so, for theirs is a more sophisticated and financially savvy approach.
STUART GRAY & ASSOCIATES