Financing your purchase can be difficult…
But there wouldn’t be much of a property market without easy access to mortgage funding.
This became horribly apparent in 2008 in the aftermath of the credit crunch when, in a state of near panic, banks began to hastily withdraw mortgages, crashing the market into reverse gear.
Fortunately mortgage funding is now back to normal and widely available. So before you start viewing property and mentally moving in to that fabulous mansion, the first question has to be –
How much can I afford to borrow?
You are about to make what is probably the biggest financial commitment of your life.
But unless you’re massively cash-rich, getting your hands on a prime piece of real estate is likely to involve borrowing large amounts of spondulicks.
The average mortgage size in Britain is between £100,000 and £150,000, but to figure out how big a mortgage you can have, the first step is to look at your income and draw up a monthly budget. This will show what sort of payments you can realistically afford to make.
Budgeting
As a general rule, your monthly mortgage payments should be no more than about one-third of your income after tax.
If you’re comfortably paying rent at the moment, or your existing mortgage isn’t too taxing, you could take this as a base figure and add a bit. If the figures look depressingly tight, you might be able to meet your mortgage payments by other means, such as taking in a lodger, or buying with relatives or friends.
But your income isn’t the only factor. It helps greatly if there’s something in the piggybank. A certain amount of capital, in the form of cash savings, shares or equity from the sale of your existing home, will be required.
Even if your bank is willing to lend as much as 90 per cent of the purchase price, you’ll still need to come up with the other 10 per cent. Although this represents a sizeable chunk of money, it should be manageable for anyone who’s built up some equity in their present home.
But as well as the deposit, as a buyer you have to budget for a number of extra costs, notably stamp duty tax, legal fees and survey and mortgage fees.
Estimated cost of buying a £200,000 property
Stamp duty (at 1% of the full purchase price) £2,000.00
Solicitor’s fees £400.00
Telegraphic transfer fee £30.00
Local authority search £200.00
Drainage search fee £60.00
Environmental search fee £50.00
Land Registry searches £10.00
Bankruptcy search (per applicant) £5.00
Land Registry fee £200.00
(to register you as the new owner)
Lender’s mortgage valuation fee £300.00
Homebuyer survey £400.00
Buildings insurance £175.00
Removals £550.00
TOTAL 4,380.00
All figures are approximate.
Most lenders charge arrangement fees and some mortgages may attract additional fees. Some mortgage brokers also charge a fee.
If you are selling as well as buying, you will need to additionally allow for estate agents’ fees and an EPC. The average cost of fees for someone moving house is around £10,000. (Source: BBC Panorama.)
Stamp duty
Buying a house means you will need a sizeable pot of spare cash to pay the Government. One of the most hated taxes, and one of the hardest to avoid, stamp duty is a tax on moving home paid by purchasers.
Rates change from time to time but stamp duty currently catches many struggling first-time buyers, thereby making housing less affordable.
At the time of writing, ‘stamp duty land tax’ (SDLT) – to give it its full name – must be paid by buyers on all transactions above £125,000. If the property’s value is less than this, you will be in the lucky minority who don’t have to pay anything to H.M. Treasury.
homes priced between £125,001 and £250,000 you pay 1 per cent of the property’s full sale price. Between £250,001 and £500,000 it jumps to 3 per cent, and above £500,001 it’s 4 per cent.
There are 2 further bands, 5% over £1m – £2m, and 7% above £2m – see home-moving.co.uk for updates.
Where the price of the property you’re buying happens to be just above a ‘stamp duty threshold’, one well-known tax dodge was to lower the agreed purchase price below the threshold and then reimburse the seller by paying an inflated price for fixtures and fittings separately.
But the taxman is wise to this, and it can be hard to justify paying £10,000 for a second-hand sofa.
The only mildly good news is if you are buying a new property some developers will pay your stamp duty as a sales incentive.
Calculating your borrowing power
The size of mortgage you can borrow depends largely on your income. But there are different types of income, so how exactly do lenders calculate the amount they are prepared to lend?
Income multiples
Traditionally, the amount you could borrow was calculated by multiplying your gross annual income by three. If you were buying with your partner banks would allow 2.5 times your joint income.
But as interest rates fell from the 1990s this seemed unduly cautious and now multiples of 4 times sole salary (x 5 isn’t unknown) or 3 to 4 times joint income are widely available. So if you’re earning £30,000 a year and your partner brings home £15,000, you may be able to jointly borrow a grand total of £157,500 based on 3.5 x joint incomes.
But in some parts of the country this won’t buy you much more than the proverbial broom-cupboard, so lenders have devised more flexible ‘affordability’ methods of calculating how much applicants can borrow.
‘Affordability’ is a more sophisticated but less transparent process that takes account of the applicant’s overall financial circumstances. It is meant to take into account the possibility of unfortunate events occurring – such as injury, illness or losing your job.
What if one of you had to stop working, perhaps because of an unplanned pregnancy?
Suppose interest rates take a hike – as they did in the early 1990s, peaking at 15 per cent.
These are all issues the ‘affordability’ test will weigh up, balanced by possible future good news, such as whether your salary is likely to rise significantly. The risk of bad things happening can, of course, be ‘hedged’ by taking out insurance for illness or redundancy (but be wary of banks mis-selling such products), and jumps in interest rates countered by arranging a fixed rate mortgage.
Does commission count?
No matter what price range you’re looking in, it always seems that the property you really want is just beyond your financial reach.
The temptation is to stretch a few thousand more. But making the sums add up isn’t always easy. The way lenders assess extra income – things like commission, bonuses, overtime payments and company cars – can make all the difference.
Basically this will depend on how your employer describes it. If they class it as ‘guaranteed’ then the bank should treat it as basic salary. More often it will not be guaranteed, in which case mortgage lenders will normally be prepared to include only half the value in their calculations.
So if your non-guaranteed commission comes to £10,000 a year, the lender may be willing to add £5,000 to your basic salary before multiplying it up. Best run this past your employer first.
Self-employed
When it comes to arranging a loan, being self-employed can make you feel like a second-class citizen. Independently earning an honest living seems to get lumped together with assorted high-risk categories and all manner of social ills.
Whereas the average employee simply has to utter the magic words ‘PAYE’ and provide three months’ wage slips or a P60 and everyone’s happy, for the self-employed there can be a mountain to climb to produce suitable ‘proof of income’.
That said, mainstream lenders should be perfectly happy if you can confirm your income by providing two or three years’ worth of accounts.
The problem is that your accounts will be drafted to (quite legitimately) minimise your tax liabilities and may not do full justice when it comes to presenting your income for mortgage purposes.
This can also be an issue if your business hasn’t been running for that long. If proving your income is difficult, perhaps because some of it is paid in cash, a good broker may be able to advise on suitable self-certification products, although the choice of lenders will be limited, ultimately costing you more through higher mortgage rates.
Self-certification and ‘non-status’
Many self-employed people find that ‘non-status’ mortgages offer a good solution.
These enable you to ‘self-certify’ your income by signing a document stating how much you earn. A broker will know which lenders are worth approaching. Most judge cases in terms of overall ‘affordability’ rather than strict income multiples.
Some lenders have been criticised for ‘turning a blind eye’ where applicants may have been tempted to grossly exaggerate their income (hence the term ‘liars’ loans’).
Obviously a bigger mortgage can lead to problems meeting monthly payments, ultimately ending in repossession. But as a safety net, ‘self-cert’ mortgages usually require a sizeable deposit, perhaps 25 per cent or more of the purchase price, and rates are often higher than the lender’s Standard Variable Rate, because of the increased risk.
If the loan is limited to 75 per cent of the value of the property, for a £250,000 home you would need to come up with £62,500 cash. The usual range of mortgages – fixed, capped, discounted etc – are available with self-certification.
Loan-to value (LTV)
Even if you’re a big earner, there are limits on what you’re allowed to borrow. The size of the mortgage loan compared to the value of the property is fundamental to the maths of mortgages.
This ‘loan-to-value’ ratio, or LTV, will crucially dictate how much the bank will lend. As everyone knows, the days of 125 per cent LTV mortgages are now history (Northern Rock weren’t the only lender to offer loans totalling considerably more than the value of the house being purchased).
At the time of writing, most lenders are prepared to lend 85 to 90 per cent of the property’s value. Higher LTVs are available if you search the market, but to qualify for the cheapest deals you normally need to borrow less than 70 per cent, because lower loan ratios mean lower risk for lenders.
High LTV mortgages cost considerably more, so as well as a spotless credit history it helps if you can come up with a sizeable deposit.
Help To Buy
Government-backed shared equity schemes can provide interest-free loans of up to 20% of the purchase price, allowing you to buy with a deposit of just 5% and a mortgage of 75% LTV.
Although not restricted solely to first time buyers, these deals are especially helpful for those buying their first home and are becoming a more and more viable option. We’ll discuss these in greater detail in another post.
Next we’ll be looking at who would lend to you and why potential lenders might consider you a risk.
