When applying for a mortgage, the lender will have a look at certain criteria before granting the loan. Willingness to pay and affordability sit high up on this list. So how do they check this?
Willingness to pay has a lot to do with your credit score. When your score is on the low side, it might indicate that you’re not in the habit of keeping up with payments.
As part of an affordability and risk assessment, the lender will check your debt-to-income ratio. They will add up all your recurring debt payments plus some additional items such as child and spousal support. This is then expressed as a percentage of your income. For instance, if you earn £5,000 per month and your debt repayments are £2,000, your debt-to-income ratio is 40%.
How to do a debt-to-income ratio check
Enter all your personal loan expenses into our calculator. You’ll see there are slots for mortgage, personal loans, credit cards, car loans, child and spousal support, and other monthly payments. These are only debt payments, so don’t add in things such as groceries or utility costs.
The “other monthly payments” can be items such as furniture accounts or store cards.
Enter your gross income in the allotted slot. This is your income before any deductions such as tax.
Hit the calculate button. Your debt to income ratio should appear on the screen instantly.
What is an acceptable debt-to-income ratio?
When you’re considering debt, it’s important to know what is considered healthy use. For instance, if you have a credit card limit of £1,500, you should only use around 30% i.e. £500. This may seem counterintuitive, but it shows lenders that you are responsible with your debt usage. When you start touching the 50% usage rate and higher, lenders might consider you as overextended which can affect your credit score. It may also affect further finance applications. That being said, your overall debt repayments should not be more than 36% of your gross income, irrespective of your credit limits.
What about car loans and mortgages?
From an affordability perspective, lenders often use the 28/36 rule. This means that no more than 28% of your gross income should go towards housing. This includes mortgage repayment, property taxes, and insurances. Your total debt repayments should also not be higher than 36% of your gross income. When it comes to car loans, the debt to income ratio shouldn’t be more than 10% of gross income. This includes maintenance plans and insurance.
What can I do when my mortgage is declined due to affordability?
When lenders decline your loan due to affordability, it could mean that your debt-to-income ratio is too high. Have a look at your credit report and see if you’re using more than 30% to 35% of your revolving credit. Another way to improve affordability is to put down a higher deposit. You may also need to increase your income or decrease your non-essential expenditure.
What is a stress test?
During a stress test, lenders might see what will happen when you max out all your credit. They may also have a look at your installments with incremental interest rate changes to see if your income can still cover all your commitments. When your credit limits are too high, your application might fail the stress test. The stress test is designed to mimic scenarios such as an economic depression.