Income multiples: Times up?
Kay McLellan
The debate over income multiples has raged for some time. As lenders move towards affordability based lending, the potential loan clients can receive, when translated into income multiples, has leapt substantially. While the heady heights of eight times income are now being seen from some specialist lenders, it is a far cry from the average 3.5 times currently being lent. Yet, as multiples rise further, the arguments continue to rage over how useful, or even responsible, such lending is. So just how far can multiples go?
The consternation seen in some circles over high multiples is not shared by all. Time and again the debate returns to the relevance of how much an individual client can afford to pay. Rachel Blackmore, head of external affairs at the Building Societies Association (BSA), points out that the days of crude income multiple calculations are gone because of the sophisticated systems lenders now use to calculate a client’s affordability.
However, despite these systems, she says risk is never removed. “Essentially, people are taking out a loan and they need to work out whether in reality they can repay the debt – something lenders also need to assess. It’s not in lenders’ interest to lend more than clients can pay back, as you just end up with defaults and a costly, heart-breaking process.”
Multiple mystery
Yet for Colin Snowdon, chief executive of Freedom Lending, the principle behind income multiples remains a mystery. He explains: “I don’t know why lenders persist with income multiples. I never could get anyone to explain to me the rationale behind them. In order for a lender to be realistic, they have to stretch their income multiples and lending criteria. If the lender usually gives 3.5 times income and it’s not enough for the customer, so they move up to 4.5 times – what is the rationale behind that?”
Affordability does not escape his censure either. Snowdon is equally scathing about lenders with a ‘black box’ approach to affordability, where brokers can’t see what processes are behind the lenders decision and have the danger of hard footprints being left on a client’s records.
The concern over whether affordability tests are always applied properly and transparently is also recognised by Bob Sturges, director of communications at Money Partners. He says: “Based on models currently available to the market, it is possible for customers to obtain mortgages that equate to seven or eight times gross annual income, and possibly more. This may be appropriate for certain individuals, such as young professionals with a relatively assured career path and future earning potential, but will certainly not be in all cases.”
As for the levels income multiples could reach, Blackmore feels there is a need to keep an eye on them. But more fundamentally she sees the need for clients to recognise what they are getting into when taking up a high income multiple product. She says: “The bottom line is people have to understand what happens in different scenarios and clearly know they are more exposed if interest rates move and they aren’t on a fixed rate deal.”
Irresponsible lending?
All this discussion surrounding high multiples has lead some industry commentators to predict future financial scandals, but the idea is quashed by many in the industry. Mehrdad Yousefi, head of intermediary mortgages for Alliance & Leicester, says: “Any lender looking to lend five or six times income has to be very sure that the customer’s estate is robust and they can pay back the loan and continue to do so in five years’ time. Mortgage lenders have to make that judgement. It would be irresponsible if everyone was just given the same income multiple.”
He adds it would be ridiculous to think any lender would intentionally seek to lend every customer the highest multiple advertised. “There are checks and balances in underwriting and mortgage lending. The beauty of mortgage regulation is there is sufficient responsibility placed on lenders and mortgage intermediaries to ensure people can afford the loan.”
Blackmore also sees the potential for clients to take on a mortgage they can’t afford as unlikely, though always possible. She says: “Lenders have very sophisticated ways of looking at affordability. The figures aren’t plucked out of the air. They’re carefully considered by the lender and broker. It’s an individual risk they have to weigh up, but that’s the nature of the business.”
“It’s difficult to say a product is wrong in itself unless you take into account all the decisions that are made. Higher income multiples, if affordable and lent responsibly, enable people to get their foot on the property ladder when they otherwise wouldn’t be able to,” she adds. “It’s because of affordability that higher income multiples have been introduced. But it’s not in the lender’s or intermediary’s interests to advise clients on a loan they can’t afford to service.
“It may be there are circumstances where it would be appropriate. But the majority of people aren’t seeking them out and higher incomes are the exception rather than the rule.”
However, Sturges warns that a systematic failure in affordability testing would lead to another financial scandal that anyone would wish to avoid. “Lenders and intermediaries know full well that they have a duty of care to ensure their borrowers, who also have a responsibility, are not taking on an unmanageable financial burden. This must extend to affordability tests to ensure their appropriateness in all cases.”
Nonsensical?
Rod Murdison, proprietor of Murdison & Browning, can’t understand where the bad press that surrounds high income multiples comes from. He cites the fact that 15 years ago, a borrower would have paid twice as much back in mortgage repayments per year as someone on exactly the same wage and income multiple today – the difference being the dramatic difference in interest rates. He comments: “It all goes back to affordability. I don’t see any harm in lending a high income multiple when 15 years ago it seemed completely acceptable lending. If the person is being loaned seven times their income, who cares? It’s the maths that counts; what the person physically parts with. It was an acceptable figure before and there was no press surrounding it. It strikes me as nonsensical that there is now. Advice should be based on a client’s personal circumstances.”
The attacks levelled at new products frustrates Snowdon. While he may berate income multiples, he feels too many people are ready to criticise new products without taking the time to consider their worth. “I get quite cross about it,” he says. “Products come out and people say it’s the next scandal without reading all the details. Lenders are trying to develop innovative products. We have problems in the market with affordability and lenders need to innovate.”
Though innovation is to be lauded and encouraged, there is something to be said for erring on the side of caution. The fact that we have been living through a very stable economic period has helped affordability models to succeed, but a potential downturn in the UK economy should be prepared for.
Sturges comments: “Affordability models have yet to be tested in deteriorating economic conditions. A catalyst for their development was the rapid rise in house prices and the low interest rate environment of the past 10 years. Combined with generally strong economic conditions that have kept employment levels high, these factors have made higher borrowing by individuals less risky. But in the event of a downturn borrowers could find themselves severely stretched.
“Some commentators believe we may be facing just such a scenario and point to rising unemployment, increasing numbers of insolvencies and slowing house prices as evidence. I think the jury is still out on this and believe the fundamentals underpinning the market remain generally strong. Nevertheless, the signs of more uncertain times ahead are there to be seen and heeded.”
Relegated to history?
So with pitfalls potentially heading our way, what is to become of the income multiple as it stands? Yousefi believes standard income multiples will be a thing of the past within 10 years given the power of electronic underwriting, while for Roy New, a sole broker, the levels multiples could go to is simply down to how much lenders want the business and how adventurous they are willing to be.
Yet, whether income multiples can continue to rise is uncertain and, for some, an unwelcome prospect. If standard income multiples do disappear from the market, it can only be hoped lenders will replace them with products that are transparent for brokers and clients alike and can help borrowers to enter the market more easily. As always, it is the borrower’s needs that must be thought of first.
