Richard Campo, founder and managing director of our recommended mortgage and protection advisers, Rose Capital Partners, answers the most common question asked by clients – How much can I borrow for a mortgage and how much is it going to cost?
The ‘cost’ question is down to product choice, which I will deal with in a later blog, but the ‘how much’ is something I will tackle here. As this will be a comprehensive blog, given it is the largest and most complex topic in all of lending, I’d suggest you do the classic ‘Ctrl+F’ to search for the section that applies to you, or if you fancy some advanced mortgage reading, enjoy!
According to the FCA, since 2007, a staggering 340 regulated mortgage lenders have had to file quarterly returns to them! If you are asking yourself, ‘Why are there so many lenders?’ – read on…
As a rule of thumb, life just seems to get more complicated as time rolls on. Nothing is truer of that than how people get paid. According to the ONS (Office for National Statistics), around 15% of the UK workforce are classified as Self Employed (which is around 4.8 million people), with that number growing. With an increasing trend of younger people being their own boss sooner (16 to 24-year olds specifically, have seen a 74% increase since 2001), either as a Sole Trader, Limited Company, Partnership, or even a combination of these, assessment of self-employed income has become more complex.
You could therefore deduce that for the remaining 85% it is simple. Sadly not. In a very competitive workplace, employers are keen to tie in staff with incentives, bonuses, commission, vesting stock options, Profit Share schemes or even equity. Below I have broken down the most common things we have seen and how lenders approach them, so you can show off to your friends how much you know and work out (roughly) how much they could borrow. Simples eh?
Firstly, some context on how lenders lend. Back in October 2014, the Bank of England chose to impose a cap on lenders – not more than 15% of their new lending could be above 4.5 x income. At the time, they felt the market was overheating and they wanted to flex their muscles following the credit crunch fall out and subsequent powers they obtained. So, for the shortest possible answer to the question, ‘How much can I borrow?’ – the answer is, about 4.5 x your income. As you will see below, how you define that income is not at all straightforward, and don’t assume banks will include all your income. While the 4.5 x income rule fits for 85% of people, there is relative free reign on the other 15%. Some lenders go as far as 6 x income and other lenders will also take up to 4 incomes into account on one application. At that end, the numbers start to get punchy.
So how is your income defined by lenders?
If you are Employed, below are the most common ways you will receive your income, along with the most common ways lenders calculate what they will use in their assessment – but as noted, there can be huge variances in this.
- Salary – lenders will take 100% of your gross salary. However, some lenders will deduct things like pension payments, student loans or childcare costs, so be mindful to work on the post deduction income
- Bonus – most lenders will typically take 50% of any annual bonuses, if there is a 2-year track record, with a few taking a larger percentage up to 100%. If any bonuses are paid more regularly, such as monthly or quarterly, some lenders will include 100% of this income. As a rule though, lenders will take 50% of any variable, non-guaranteed income
- Commission – very similar to the above for bonuses
- Stock options/vesting stock schedule – Typically these aren’t classified as income by most lenders (even though in the real world they very much are). That said, some lenders will include this either as income (most typically Private Banks, or lenders that understand Higher Earners income) or towards the repayment strategy of an Interest Only loan
- Zero hours contracts – Most lenders will require 12 months minimum track record and use the total income in the assessment, or P60, whichever is easier to evidence income, then treat as a salary
Example – below is a simple, real world example, of how lenders treat the above and the wild variances that it then creates in how much you can borrow:
- Client A earns a basic salary of £50,000 and quarterly bonuses that equate to another £50,000pa.
- Lender A offers the standard assessment and therefore a loan of £337,500 (100% of basic, plus 50% of bonus x 4.5 = £337,500)
- Lender B offers to take 100% of the bonuses into account and a higher multiple of 5.5 x income, and therefore will offer a loan of £550,000
Both the above are standard criteria of high street lenders, proving that if you don’t shop around, you could be offered a staggering £212,500 (or 63%) LESS from different lenders – making a huge difference to your house hunting. The actual amount offered may vary depending on your deposit level and credit profile, as described in the sections below. Also, don’t assume just as you borrow more, the rate is higher, often the converse is true. The rate is determined by the lender, then their criteria is applied, not the other way around.
Self-employed income
If you are Self -Employed, it is more complex (and bear in mind, most lenders will classify you as self-employed if you own 25% or more of the shares in a company). Ideally, you’ll have a two year + trading record, but some lenders will work on just one year. With less than a year trading it is generally not possible to get a mortgage unless you have moved into Contracting, so skip ahead if that is you. The easiest way to describe it is that lenders will include one, some, or all the following forms of income:
- Salary
- Dividends (some lenders even ‘gross up’ the Dividend, which really boosts what you can borrow)
- Net profit (or Profit on ordinary activities before tax for a Ltd Co)
- Drawings (if an LLP)
The general rule is that the income over the last two years is averaged, assuming income is stable or on an upward trend. If there is a downward trend, questions will be asked, but if there is a good reason, it will be the most recent year, not the average that is taken. Conversely, on a healthy upward trend, some lenders will just take the most recent (higher) figure. As a rule, retained profits can’t be used, but that does show in the ‘Profit on ordinary activity before tax’ section of the accounts, so I would recommend if that applies to you, you use a lender that looks at that. Some payments like pensions can be added back in as well. If there has been a loss in the last two years, most lenders will flat decline the application, but some more pragmatic lenders can take a view if there is a good reason. Confused yet?
So again, giving a simple example:
- A client has a Ltd Co which has been trading for three years, for argument sake, the averages come out at:
Salary = £12,500
Dividends = £87,500
Net Profit = £87,500
Profit on ordinary activities before tax = £100,000 (or POOABT)
- Lender A just looks at Net profit, and offers a 4.5 x multiple, therefore a loan of £393,750
- Lender B just looks at POOABT and applies at 5 x multiple, offering a loan of £500,000
- Lender C looks at salary and dividends (and ‘grosses up the Dividend) and offers £550,000
This is by no means exhaustive, however hopefully illustrates yet again, the huge variances that can be offered to the same client.
The assessment is also key. You can look at SA302’s, Accountants reference or Accounts, so finding the simplest assessment method is also part of the puzzle, as that needs to be overlaid with the lenders criteria to ensure you get the right outcome (I didn’t say it was simple).
Contractors
If you are a Contractor, this is a middle ground between being employed and self-employed. From a tax point of view, you will typically be self-employed and may have even set yourself up as a Ltd Co, however many lenders will treat you as a pseudo employee. Ideally, there would be a 12-month track record, and a history of 3, 6, 9, or 12-month contracts under your belt. But in some instances, lenders will take your very first contract if it is in the same line of work and you have a strong CV/Day rate.
A typical assessment of a contractor would be:
The x 5 (or however many days a week worked) gives a weekly figure, then a 46-week year is used to allow for gaps in contracts. Again, the figures would break down as:
A six-month contract, on a day rate of £450 would mean you are typically offered a loan of £465,750 (450 x 5 (days) x 46 (weeks) x 4.5 (multiple applied). Most lenders will go to 5 x income on these cases, so getting a loan of £517,500 on that example would not be too hard.
However, if the lender does not understand contracting (which is most lenders), they will treat you as self-employed. As an example, let’s say you run that contract through a Ltd Co (which is the sensible thing to do), your net profit may only show circa £50,000 once you have allowed for costs. In that instance, a lender may only offer a loan of £225,000 (£50,000 x 4.5), which is less than half of what you can get elsewhere! So, the key is – work with a lender that understands contractors and does not asses you as being self-employed.
If you have both self-employed and employed income (which we are seeing an increasing amount of), more and more lenders will apply the relevant assessments above for the differing ways in which you get paid.
Deductions
Taking all the above into account, lenders do not blindly offer loans without looking at your wider situation. Therefore, any outgoings that will remain post completion will be considered BEFORE the above multiples/assessments are applied. In the simplest terms:
- Credit card balances are deducted at 5% of the balance x 12
- A card of £10,000 would equal a £6,000 deduction from your income (£500 x 12)
- Loans, HP agreements, Interest Free loans (life DFS etc), are taken at the monthly payment x 12
- A loan of £200 a month would be a £2,400 deduction from your income £200 x 12)
- Childcare costs like Nannies, Nursey Fees or Private School fees are treated as loans above
- Not all lenders make this deduction, but the majority do.
Hence, to gain a true picture of what you can borrow, minus the deductions above from your income as relevant, then apply the correct assessment and income multiple and that is what you can borrow. Almost there…
Passive income
What about passive income, such as?
- Rental Income
- Shares
- Trusts
- Maintenance
- Lodgers
- Pension
As a rule, apart from Pensions (see Employed salary above, as it works the same), most lenders discount this income. That is not to say all lenders won’t include it, but it is not common.
Now you can see why there are 340 lenders to choose from! There is a lender out there for everyone, but as ever, getting the right advice, at the right time is key. A good broker will know how to navigate this very complex web and have the experience and tools at their disposal to present a case correctly, with the right lender, to get the right outcome.
For an accurate assessment of your current situation, or if you have any other mortgage related queries, please do not hesitate to get in touch with one of our advisers and we will be happy to guide you as best we can.
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