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One of the most crucial steps in the journey to buying a new home is figuring out how much you can afford to spend. Understanding your mortgage affordability is key to setting a realistic budget and ensuring a smooth purchasing process.
Understanding Mortgage Affordability
Calculating your mortgage affordability involves assessing your financial situation to determine the maximum amount you can comfortably borrow for a home loan. By evaluating factors like your income, expenses, debts, and credit score, you can gain a clearer picture of what you can afford in terms of monthly mortgage payments.
Steps to Determine Your Mortgage Affordability
Step 1: Assess Your Financial Health
Begin by taking stock of your financial situation. Calculate your monthly income before taxes and deductions, and list out all your recurring monthly expenses, including loan repayments, groceries, utilities, credit card payments, student loans and any other regular payments.
Step 2: Consider Your Debt-to-Income Ratio
Lenders typically use a debt-to-income ratio to assess your ability to manage monthly mortgage payments. This ratio represents the percentage of your gross monthly income that goes towards paying debts. To calculate yours, divide your total monthly debt payments by your gross monthly income.
Step 3: Evaluate Your Credit Score
Whilst you credit score does not directly correlate to how much you can borrow. The better your credit file, the more lenders you may have open to you, which in turn allows you to potentially go with lenders who may be more generous in terms of affordability. Better credit file history can qualify you for better interest rates and loan terms. Check your credit report and ensure it is accurate before applying for a mortgage.
Step 4: Other incomes
If you have other income types and not just personal salaried income then this may change how your affordability is seen. these can be any of the following:
Overtime
Bonuses - yearly/quarterly/monthly
Commission based job where you get part salary and largely part commission
Rental income
Dividend income
Benefits
Allowances
RSU's
These each have their own method of assessment and different lenders will take each of these and assess them different for affordability purposes. Maybe they take overtime at 50%, maybe they don't take benefits at all, maybe they take commission at 10% over the last 3 months or lower of the last 3 months or a previous p60. There are so many variables when it comes to assessing extra incomes so you will definitely want to seek advice on these to know how they can be used towards your affordability.
Calculating Your Mortgage Affordability
To calculate your mortgage affordability, you can use online mortgage affordability calculators offered by many financial websites and institutions. These tools take into account your income, expenses, debts, and credit score to provide an estimate of the maximum mortgage amount you can comfortably afford.
A general rule of thumb is 4.5x your yearly income is what you may be able to borrow. This is however on the assumption that you do not have outgoings such as outstanding credit card balances, personal/car/student loans.
There are instances where if you meet certain criteria, you may be able to borrow more than the typical 4.5x yearly gross income. this will be in a separate blog.
The 4.5x rule works for most lenders, however, if there is less than 25k of income as a whole on the application then it does have potential to be less than the 4.5x with quite a few lenders. This is due to the cost of living taking up a larger portion of a persons income comparatively to those who earn a larger income. Meaning there is less expendable income for them at the end of the month to afford a mortgage. This is not always the case but for many high-street lenders this may be the case.
Example Calculation:
Assuming your gross yearly income is £40,000 and you do not have dependents or loans/credit card balances. You may be able to use the 4.5x salary conversion in which £180,000. Use this figure + your deposit to find your total house purchase price. Inclusive of a £20,000 deposit (for the sake of this that is the figure we are using but you may have a larger or smaller deposit.) this would give us a purchase price of £200,000.
Some lenders may be offering 4.75x income or 5x income to certain deposit % and income sizes and even up to 5.5x or 6x. Like previously mentioned this will be in a different blog.
Final Thoughts
Understanding your mortgage affordability is essential in the home buying process. By taking the time to assess your financial health, evaluate your debt-to-income ratio, and consider all associated costs, you can confidently determine your home buying power and set a realistic budget for your next house.
Whether you are a first-time buyer or a seasoned homeowner, knowing your mortgage affordability will empower you to make informed decisions and find a home that not only fits your needs but also your financial capabilities. Take the time to crunch the numbers and embark on your home buying journey with confidence!
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