Weighing up the options on lending calculations

Income calculations are hardly the stuff that columnists\' dreams are made of but stick with me on this one, as I reckon there is a real need to blow away some of the hype surrounding the treatment of income. Some important points about lending calculation are not getting the exposure they deserve.

So, income multiples or affordability calculations – which way to go? I doubt many will disagree when I say there are problems with income multiples. They are open to obvious criticisms. Some people think they are inflexible while others say they contribute to a tendency toward non-compliant mortgage sales.

If you are a betting person the odds on the income multiples nag don’t look too good in the lending calculation stakes. But there are a few compensating arguments in their favour. Primarily, they are tried and tested, and they are easily understood. And that, in many respects, is the essential saving grace of the income multiple. From the intermediary’s point of view the calculation is straightforward. In a mortgage interview you can give your client a pretty accurate idea of what can be borrowed. Sourcing systems will do similar calculations.

Consider then, the alternative of using affordability calculations. If you as an intermediary have transacted with the lender, fine, but if you haven’t the process is complicated.

You will have to download and install software. You might even have to obtain a CD. When you have the software you can input information into the system and, lo and behold, you can tell the client what they might be able to borrow. That, in a nutshell is the problem with affordability calculation. It removes intermediary skill – and that I see as a problem.

This represents yet another example of the process flowing backwards from the lender to the intermediary.

And remember that intermediaries will be making their own affordability calculations anyway.

I acknowledge that income multiples need an overhaul. The multiples on offer have not shifted dramatically since interest rates were in double figures in the early 1990s. The industry must urgently review these levels.

Some lenders appear to be confusing two processes. In the past the process of the affordability calculation was, within many lenders, the preserve of the underwriter. The case was presented to the lender by the intermediary using income multiples. As a back-up and justification for the mortgage amount requested, the affordability calculations were then made by the lender. Occasionally cases were marked down when there was evidence of high indebtedness, but only occasionally.

The picture beginning to emerge now is of a far more complex and less certain process being pushed back onto the intermediary. What next?

Will affordability calculators offer a durable solution to lending calculations? They are no panacea. There are benefits to both systems. But I reckon the two should be used in tandem, not exclusively. Subject to lenders adjusting their income multiples there is still plenty of mileage in the established principles of income multiples and underwriting working together.