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Mortgage lenders take several factors into account before deciding how much they would lend to borrowers. To minimize their risk, lenders perform a detailed analysis on the income and expenses of the borrower.
Earlier mortgage lenders would simply provide mortgages based on the borrower's income. For example, if you were earning £60,000 the lender might have offered three to five times of this amount or between £180,000 and £300,000 without taking any other factors into account.
New rules for mortgages from April 2014
In April 2014, FCA, the financial regulator, carried out an extensive review of the mortgage market, named as the Mortgage Market Review (MMR). After the review, the FCA has announced more stringent rules for lenders, making it tougher to get a new mortgage.
With the new rules, a mortgage lender will decide on the loan amount after taking into account three factors:
- Stress test for any unexpected future events
Just like earlier, a mortgage lender would want to know the sources of income for the borrower. Lenders take the following income into account:
- Basic income
- Extra income such as commission, bonuses, income from a part-time job, etc.
- Income from savings or pension
As a proof of income, you are required to give pay slips and bank statements. If you are self-employed, you have to provide your business account statements, bank statements, and information on income taxes paid to the mortgage lender.
As per the new rules, mortgage lenders cannot provide a mortgage of more than 4.5 times of the annual income. So a borrower with an annual income of £60,000, cannot get more than £270,000 in mortgages.
Apart from income, mortgage lenders are required to perform an affordability assessment to understand how much a borrower can pay in monthly repayments. Lenders will look at your living expenses such as:
- Bills for household expenses such as council tax, gas, electricity, broadband
- Credit card outgoings
- Insurance expenses
The lender will also ask how much you spend on clothes, holidays, and other leisure expenses. At times, lenders may validate the expenses from your recent bank statements.
Along with assessing income and affordability, mortgage lenders are also required to carry out a 'stress test' on your repayment ability. A stress test will take into account any future events which may affect your repayment ability. Such events will include:
- Potential increases in interest rates
- A loss of job for either you or your partner
- Changes in lifestyle such as the arrival of a baby
Questions for borrowers:
As part of these tests, some questions the lenders may ask the borrowers are:
- Whether you have ever taken a payday loan?
- Are you into gambling?
- Do you plan to have children in the future?
- Whether you have any plans to become self-employed?
Based on these tests, the lenders will get an accurate idea of the present and future repayment ability of the borrowers, and decide the loan amount accordingly.
Use our mortgage calculator to calculate the repayment amounts for different mortgage amounts at different interest rates.