Each and every mortgage is a risk for the lender, and as such they have to assess that risk and see if it is worth lending out the money. The lender will have to minimise the risks from their end, particularly when it comes to attempting to reduce the number of borrowers defaulting on their payments.
In theory, these risk assessments performed by the lenders should ensure the lenders are not suffering in loaning out money, as well as reducing the likelihood of borrowers ending up in a dire financial situation.
There are a number of common factors that the majority of lenders will look at in these assessments, but there are no guarantees which factors they will look at, and in the majority of cases, banks will not publish exactly what they assess when looking to lend.
Outgoings when applying for a mortgage
Usually lenders will look at the amount of money that the borrower spends in a typical month, factoring in all of the possible outgoings. Luckily for prospective borrowers, a lender is not going to expect a person to spend 100% of their income on paying back their mortgage.
Various living and personal expenses are calculated or estimated and taken into account during what is knowns in the industry as an affordability assessment. Following an exhaustive review of the mortgage market in 2014, the Financial Conduct Authority (FCA) decided that lenders must use more strenuous and thorough checks to determine whether an applicant is worth lending to, in an attempt to ensure stricter and safer banking decisions.
Once the outgoings have been calculated it is possible for the lenders to work out what level of monthly repayments the borrower can afford.
Credit history and rating
Lenders are likely to make judgements based on, or at least incorporating, the applicants credit history in order to better judge and decide on a borrower’s reliability and likeliness to repay on time.
Your personal credit history is determined by your past loans, how often you have defaulted on a loan, any payday loans taken out, as well as various other factors.
Stress testing the finances of a mortgage applicant
The FCA have also made it mandatory for lenders carry out a stress check on people looking to borrow money on a mortgage. This requires lenders to assess and predict the effects of some kind of financial emergency or emerging situations, in order to better gauge whether they will be able to cope reasonably well and recover without being put in a precarious position.
For example, whether the borrower would want to have a child, and the mortgage lent would have to be adjusted accordingly to ensure that the borrower could keep up repayments.
One of the most obvious factors that lenders will look at is the income of the person wishing to borrow.
In the vast majority of cases, a borrower will need some form of monthly income in order to make the repayments set by the lender. As such, the lender will look at a person’s income and calculate how much they will be willing to let that person borrow, as well as estimating how much they will be able to pay back per month.
Income does not necessarily mean the amount that you earn through wages at work. The lenders will also look at:
- Income from investments
- Income from pension
- Income from child maintenance or grants
- Any other forms of repeated income
From this information, the lender will work out your loan-to-income ratio. This is usually a multiplied amount (usually three or four times) of your annual salary, and it is used to estimate a sensible amount to lend.
For example, a person earning £30,000 a year may be given a loan-to-income ratio of £120,000 (four times their annual income) .
Since the reviews of 2014, there has been a cap instigated on the loan-to-value ratio of four and a half times the annual income of the applying borrower.
An application from multiple people can boost the amount that will be available for them to borrow. A joint income will also make it easier to afford not only the repayments, but the costs of living, and is more likely to leave extra as disposable income.
A lot of things can affect whether a person is considered a risk or not by a lender. One of the most surprising reasons is whether you are on the electoral roll or not.
This is because it makes it much easier for the lender to check out a person’s legitimacy. If a person is on the electoral roll, it is much easier to check their address, and therefore lessens the likelihood that the individual applying is fraudulent.