There is no doubt that the increased use of affordability calculations by lenders has been a step in the right direction for the mortgage industry. They quite literally give ‘credit where it’s due’. If an applicant is unencumbered by large amounts of debt the use of an affordability calculation will usually result in them being able to borrow more than traditional income multiples permit.
Income multiples have been around for donkey’s years, because they are easy to understand and simple to implement. They have served underwriters and lenders well for an awfully long time and sit very comfortably on sourcing systems. In summary, they are straightforward to use for everyone involved: lenders, intermediaries and borrowers.
The problem, however, is that income multiples strength is also their source of weakness. Simplicity means they are inflexible both to changing interest rates and borrowers individual financial circumstances, which is why an increasing number of lenders have decided to replace them with a method of calculating affordability which is more in tune with the needs of today’s mortgage market. The Council of Mortgage Lenders (CML) estimates that approximately 50 per cent of lenders have some form of affordability calculation in use.
The benefits of affordability calculations
Income multiples have remained steady at approximately three times the main income plus the whole of any secondary income, or 2.5 times joint (or thereabouts) for at least the past 30 years. During that time, however, house prices and interest rates have fluctuated far more dramatically. Income multiples also focus on gross income and, as financial advisers know only too well, gross income doesn’t give a definitive indication of a borrowers financial capacity to repay a mortgage.
Affordability calculations therefore make more sense. It stands to reason that, if you take two borrowers with identical incomes where one has a high level of family expenditure and significant levels of debt and the other has modest running costs and no additional debt, then one can probably afford to borrow significantly more than the other. What matters is not gross income as used by income multiples, but net disposable income as used in affordability calculations.
Unfortunately, at the moment most lenders affordability calculations are different – there is no such thing as an industry standard. To compound the problem, many lenders have also taken a ‘black box’ approach to affordability calculations, i.e. they do not divulge the formula they use to intermediaries, preferring instead to make brokers use an affordability calculator, which is either available on their website or via free software. Although these are usually quite easy to use, they are frustrating for brokers as they do not allow them to easily explain to their clients how a maximum loan figure has been determined. They also require financial advisers to have access to a computer, which may not always be the case if the broker is making a home visit.
A major headache
This lack of transparency has also caused a major headache for sourcing systems, which simply cannot accommodate affordability calculations in a meaningful way at the moment. In fact, where lenders do use affordability calculations, some sourcing systems will simply revert back to a good old income multiple in order to quote a maximum loan amount, which is not at all helpful. In fairness to the sourcing systems, they have been asking lenders to divulge the formula they use for some time but, to date, lenders have been reluctant to do so.
A few lenders do have a transparent approach, where their affordability calculation is openly published and clear for all to see, but they are very much in the minority. Most brokers have little option, therefore, but to log-on to a lenders website and start feeding data into their affordability calculators.
We have been undertaking a detailed analysis over the past few weeks of the difference between lenders affordability calculations – information we shall be sharing with our members shortly. We are also considering developing an affordability calculation portal, so brokers only have to visit one site rather than spending hours surfing for the information they need. As I’m sure you can appreciate, there is a fair amount of analysis involved in such an exercise and I’ll let you know when there is something for you to take a look at.
New business opportunity
Affordability calculations represent an excellent new business opportunity for brokers, because many borrowers are unaware of their existence. Ask most consumers if they know how much they can borrow and they will probably quote a multiple of their income in reply. It’s hardly surprising – the mortgage industry has spent at least the past three decades telling consumers this is the way it is done.
However, this presents an opportunity for brokers to promote the benefits of affordability calculations to their clients. There are probably thousands of borrowers out there who believe they are restricted in their ability to borrow because of income multiples and have therefore not bothered to find out what deals are actually available to them. This is an issue where a bit of local PR – an article in a local newspaper, for example – could pay dividends for brokers.
However, brokers are not encouraged to take this proactive approach at the moment because of the many and varied affordability calculation methodologies being used by lenders. It isn’t simply a case of being tedious work having to plough through numerous lenders websites, it is also difficult trying to educate the general public when there is not a single simple model, dare I say like income multiples, which can be used.
Affordability calculations are without doubt a breakthrough but there is still much that can be done to make them more user-friendly. The starting point has to be to have them accurately specified on sourcing systems.
