DEPUTY CHIEF EXECUTIVE, MORTGAGES PLC
One of the ‘quiet’ revolutions that has taken place in the mortgage market over the course of the last year has been a switch from assessing mortgage applications using traditional income multiples, to the use of more flexible and accommodating affordability calculations.
I believe that, in due course, we will look back on this development as something of a revolution. Income multiples have dominated mortgage underwriting for as long as most of us can remember, but they have increasingly created problems for borrowers who, because they are unencumbered with large amounts of debt, can afford mortgage payments which traditional income multiples do not normally permit.
Just a few months ago, affordability calculations were a rarity, but today their usage among lenders is becoming increasingly common, regardless of whether they specialise in prime or non-conforming business.
Flexible and realistic
Setting maximum loan limits by using affordability calculations is a far more flexible and realistic way of determining loan limits than using rigid income multiples. It stands to reason that, if two applicants have exactly the same gross income, but one has significant credit card and personal loan debts and a high cost of living, whereas the other has no debts and modest living expenses, then one applicant can probably afford a larger mortgage than the other.
However, basing loan limits on gross income completely ignores the personal circumstances of the applicant and treats all borrowers on the same gross income in the same way. This is clearly nonsensical in an era when levels of personal debt are at an all time high and an increasing number of applicants now have more than £10,000 worth of additional non-mortgage borrowing.
Income multiples are also unresponsive to changing interest rates. For as long as I can remember, income multiples have been three or 3.5 times main income plus one or 1.5 times any secondary income – or 2.5 times joint (or thereabouts). Income multiples have hardly moved during a period when interest rates have tumbled from 15 per cent in 1989 to 4.5 per cent today. Nowadays, a £100,000 25-year repayment mortgage will cost just over £630 a month, depending on the precise standard variable rate (SVR) of the chosen lender. Back in 1989, the same loan would have cost more than twice that amount and yet income multiples have not changed.
The regulatory effect
Regulation in the mortgage market has also had a part to play in the rise in popularity of affordability calculations, particularly the necessity to demonstrate that affordability has been properly assessed. Affordability calculations fall in line with the Financial Services Authority’s (FSA) desire to show that brokers and lenders have taken into consideration the borrower’s ability to repay their debt, both now and in the future. Income multiples do not.
There is also another obvious reason why affordability calculations have proven to be so popular – they allow some applicants to borrow more money than traditional income multiples would normally allow. The important point, however, is that affordability calculations enable this to happen in a responsible way, rather than by simply increasing income multiples to four or five times main income.
Since launching our affordability calculator last year, we have seen a decline in the number of self-certification applications we have received, particularly from borrowers in full-time employment. I believe the reason for this is because our affordability calculation enables borrowers in full-time employment to make a ‘legitimate’ application, without needing to find ways around income multiples.
There is, therefore, no doubt that affordability calculations represent a huge step forward for mortgage underwriting, which is why lenders have been so eager to incorporate them into their lending criteria. However, this doesn’t mean that affordability calculations are without their problems.
Key issues
One of the key issues at the moment is that best-buy tables simply don’t know how to accommodate affordability calculations – so they don’t. The same goes for sourcing systems and many of the web-based mortgage price comparison sites. Sourcing systems have been talking to lenders about the details of their affordability calculations, so let’s hope this is an issue which is resolved quickly.
An issue which sourcing systems have to contend with – not to mention brokers and borrowers – is that most lenders adopt different approaches to calculating affordability. Regrettably I don’t see this being a VHS/Betamax type battle in which one system eventually wins out. I see lenders maintaining their own very different approaches for some time to come. This isn’t necessarily helpful to brokers or sourcing systems, but is something they will have to learn to live with.
Perhaps one of the most important issues is that most consumers are completely unaware of affordability calculations. If borrowers have any understanding of the way in which lenders calculate maximum loan amounts, it will be based on income multiples. If they refer to the press, listing tables or mortgage websites, they will be provided with information which enforces the income multiple approach. Borrowers need to understand, however, that their applications can be assessed based on their affordability rather than a simple multiple of gross income. To me, that means advertising, PR and all the other marketing communications techniques being used to full effect.
This lack of consumer awareness represents an excellent opportunity for intermediaries to sell this facility to their clients. Our experience is that affordability calculations are leading to a reduction in the number of self-certification applications, particularly from borrowers in full-time employment. I suspect this is a trend that will continue because, from a compliance perspective, affordability calculations overcome most of the problems that self-certification creates.
