2014 witnessed the Mortgage Market Review. The regulator's knee jerk reaction to the causes of the financial crash, which occurred just 6 years earlier. It tightened affordability rules and rid lenders of their love of multipliers of income, which they had cherished for many years.
It brought tight affordability guidelines and based payments around a stressed interest rate rather than the current ultra-low one.
Lenders reacted by applying tech to the problem. A spreadsheet is put into an app. So every lender has their Decision in Principle or DIP engine online, which you use to find out how much they are willing to lend a client.
But what's under the bonnet?
Income comes first. Profits, salary, bonuses etc
Less expenditure of the client:
- Mandatory expenditure such as loans and credit cards. Existing mortgage payments that are not being repaid. Anything that is contracted and challenging to cancel.
- Cost of living spending. Many engines use government statistics for average expenditure for typical families. The Office of National Statistics (ONS) provides this.
- Discretionary spending can affect some DIPs, but the ONS figures will pick this up.
This gives Net Disposable Income, or NDI, which lenders use to decide how much a monthly mortgage payment will buy. Typically they will allow 80% of this to match the monthly payment.
The monthly payment this NDI matches is the amount at the stressed rate, typically 4 or 5 % above the charging rate. This reflects their view of where rates may rise and whether the client can afford the increased payments.
Knowing the "under the bonnet" calculations can help you coach the client to maximise their affordability. Particularly important for first-time buyers trying to get on the housing ladder.