Affordability at a stretch

The ratio of mortgages to salaries may be on the up but lenders are still behaving responsibly, says Stephen Pritchard

A decade ago, someone wanting to buy a home had little choice but to look for somewhere worth between two and a half and three times their salary, plus whatever they had to hand as a deposit.

A decade ago, someone wanting to buy a home had little choice but to look for somewhere worth between two and a half and three times their salary, plus whatever they had to hand as a deposit.

But in the past few years, mortgages based on far more generous salary multiples - in some cases as much as eight times - have become possible. And with house prices continuing to rise, there is plenty of demand from buyers who want, or need, to stretch their borrowing power.

Figures from the Council of Mortgage Lenders show that the ratio of mortgages to salaries has crept up steadily since the early 1990s, when interest rates were at their peak. In 1990 the median loan for movers was 2.13 times salary, and 2.31 times for first-time buyers. In the first quarter of this year, the figures had risen to 2.72 times and 2.88 times respectively.

Average salary ratios mask a wider variation in how much some homebuyers are borrowing, with some lenders granting loans that are twice as large as conventional lending ratios suggest.

According to Ray Boulger, a senior technical manager at the mortgage brokers Charcol, lenders' published salary multiples increasingly represent the worst-case scenario. Borrowers can certainly ask for more, especially where the loan is assessed on the basis of "affordability".

Mr Boulger says that this is justified by changes to the interest rate environment. In 1992 rates peaked at 15 per cent. Few industry observers now believe that bank base rates will go as high as half that level. Most feel that base rates will peak at about six per cent in the current cycle.

This allows lenders to take a very different view on how much borrowers earn, especially if they take out fixed-rate loans. "The question is not whether salary multiples should be higher, but how much higher they should be," Mr Boulger says.

In the current interest rate environment, loans of between four and five times salary would be affordable to most people, mortgage experts believe. Mark Harris, the managing director of Savills Private Finance, says: "Multiples of up to five times are possible. It is not simply a southern bias but affects the entire country. I suggest it affects about five per cent of the market."

He adds that many lenders are happy to consider income stretches, with the banks rather than the building societies most amenable. Discovering which banks are open to offering higher loans is not always straightforward, because banks have moved away from publishing their maximum multiples, through fear of criticism for irresponsible lending. One guide is if the bank or building society talks about assessing loans on affordability. This usually indicates greater flexibility than standard salary multiples.

Mr Boulger points out that lenders can be more flexible, not just because the interest rate environment has changed but because they have better information about a borrower's circumstances and track record. Cleverer credit scoring and electronic access to data makes it much easier to make a tailored decision.

Affordability is based on the borrower's disposable income, after tax and commitments such as school fees and especially other loans are taken into account. If a borrower has an after-tax salary of £50,000, but debt repayments of £5,000, the lender would work out the mortgage based on £45,000 rather than the total salary. Factors, such as credit score, available equity, the type of mortgage and even their profession come into play.

Some lenders, such as Scottish Widows, have mortgages specifically designed for homebuyers in the professions, such as doctors and lawyers. They can borrow up to five times their income because they have clearly defined career paths, with significant salary increases along the way.

But banks can show flexibility to young professionals, even where they do not have a specifically designed mortgage. At Charcol, Mr Boulger points out that affordability means something quite different for a graduate starting on his or her career, with good prospects, and for someone in their forties, who might only see inflation-based pay increases for the rest of their career.

Absolute salary is a key factor. Wealthier borrowers can arrange larger mortgages based on affordability: many of the basic costs of living do not rise directly in line with salary, so more of the borrower's net income is available to service the debt, after other bills are taken into account.

And if a lender is to arrange a mortgage for more than the conventional salary, the higher the deposit the better. "We had a client who could only prove income of £100,000 but wanted to borrow a million pounds for a £2m property," says Mr Boulger. "But he also had money coming in later on from the sale of a property. You could argue that it was a very high multiple, but it was cheaper than a conventional bridging loan."