FOOL SCHOOL
Working Out How Much You Can Borrow

April 25, 2003

Okay - so you've decided to get your foot on the housing ladder. You're fed up with having to ring up the landlord because the shower has gone wrong yet again. The view of everyone else's dustbins from your kitchen window is beginning to get to you. And you've suddenly realised that the rent you've been flushing down the pan every month would be much better spent on buying a place of your own. Good. So what happens now?

First of all, buying a house or flat is an expensive business so it's a good idea to work out whether you can afford to borrow enough to get on the local property ladder in the first place - before the mortgage lenders smugly suggest that "You must be joking!"

Salary Multiples

Generally speaking a mortgage lender will let you have about three times your gross salary, sometimes a little more. If you're buying with a partner then they'll probably throw in the equivalent of his or her annual salary in addition to the amount they're prepared to lend you. So, if you're on £20,000 a year and he or she is on £15,000, you should be able to borrow around £75,000. Alternatively, they may lend you two and half times your joint income. This usually means you can raise a slightly bigger mortgage. In the above example this would mean they could lend you £87,500. If you get any additional income from bonuses or commission this may be taken into account as well.

More recently, in response to rapidly rising house prices, some lenders have been tempted to lend on higher multiples. This is best avoided if possible. OK, if may mean you'll get a slightly better home but you'll be left with a great, big nasty additional pile of debt to pay off as well.

Do some sums and work out how much you're likely to be able to raise via a mortgage. Is it enough, bearing in mind the price of property in your patch?

Deposits

The next thing to think about is the deposit you'll need to buy the house. Usually a mortgage lender will loan you up to 95% of the value of the property which means you'll have to come with the rest. If you want to buy a house worth £100,000, you'll need a deposit of £5,000! Do you have any savings that you can use? Can you raise the money by other means, if you haven't? Can your parents help?

There are certainly lenders who will give you a 100% mortgage but you're likely to pay over the odds on the interest rate because you'd clearly be a bigger risk. After all, if you default on the mortgage, they'll want to be sure that they can get their money back in full.

The larger the deposit you put down, the lower the rate of interest you are likely to get. A larger deposit also reduces the risk of you going into "negative equity". This is the nasty situation when the value of your house falls to below that of your mortgage. This makes it difficult to move house as if you sell up the proceeds won't cover the mortgage, and you would need to find additional funds from elsewhere.

Other Costs

Another consideration is the various costs associated with buying a home. It's not just a case of finding the deposit and knowing how much your mortgage payments will be each month. The moment you've found the home of your dreams and have had your offer accepted, you'll find that lots more people come crawling out of the woodwork to mug you for all sorts of additional expenses. The least of these is working out how to move your furniture from one place to another.

The main things you need to think about are valuation, survey and legal fees (probably in the region of £1,000 to £1,500), as well as the dreaded stamp duty. We'll have a look at the first three in more detail later but, since the stamp duty may well be the biggest single expense of buying a home, you might as well know the bad news now.

Stamp duty is payable to the lovely Chancellor of the Exchequer whenever you buy a house valued at over £60,000. Yes, it's a tax you pay for the privilege of buying your own home!

It works on a sliding scale like this:

• Up to £60,000       nil
• £60,001 - £250,000    1%
• £250,001 - £500,000   3%

You don't want to know what the tax is on houses valued at more than £500,000. (Oh, all right then, it's 4% - which translates into a minimum of £20,000! Just for buying a house!)

So, be aware that you may need to find several thousand pounds for the deposit, fees and stamp duty - just to get started on buying your own home. The next step is to assess your monthly income and expenditure. Just because someone is prepared to lend you the money, that does not mean you will necessarily be able to afford it!

More: The Homeowning Centre