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Affordability testing is changing

There have been many articles circulating in the media for the last few days claiming lenders are getting tough on the cost of living crisis. Some inflammatory commentators suggest lenders are deliberately squeezing some borrowers out of the market and other frankly wrong comments.

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To be clear, things are changing and it will get more difficult to get a mortgage for some. What is important to note is that lenders are not changing anything they have been doing for many years. Unfortunately, it is the cost of living crisis that is causing the impact. It is not something lenders are going out of their way to do.

Essential Spending

Refer to my mortgage affordability guide on essential spending here.

Lenders as required under regulation must assess all borrowers' ability to afford the requested mortgage. Part of that assessment is to look at what is referred to as essential spending. There are two options available to lenders.

Actual Expenditure

This method is the one most lenders started with around 2014 when the new mortgage assessment method was introduced. Essentially, lenders take the borrower's bank statements, go through them line by line and come up with a figure that the borrowers spend each month.

This includes everything, spending on shopping, insurance, eating out, clothes and so on. The way I did it back then was to add up all the essentials and discretionary spending, average it over 3 months and that was the figure that was added to the borrowers' costs to cover their actual spending habits.

The issue with this approach was that it was very labour intensive and caused delays. It was also unfair in some ways. If a borrower happened to have a high spending month or two that was not ordinary they were effectively penalised as lenders didn't look much beyond 3 months.

Modelled Expenditure

The alternative approach that most lenders use today is to model expenditure. This approach uses information supplied by the ONS - Office for National Statistics.

It varies from lender to lender of course but the idea is to look at the following elements:

  • Number of applicants
  • Number of dependents
  • Net monthly/annual salary of all applicants

Using the above information in conjunction with ONS data a lender can model spending. The value used is the minimum amount required for the applicants and their dependents to live on as an absolute minimum based on their net income.

This is a fairer method. It treats everyone the same. The only difference is that the higher your net salary the higher your modelled expenditure will be. If you are on a lower salary then that is reflected.

It is a quicker method and reduces processing so fewer delays in getting approval for a mortgage.

ONS Data

I won't get deep into the detail of the ONS data in this article. So an overview will suffice.

The ONS data takes a selection of items associated with a home and general living. It looks at the costs of each item every so often and produces data that lenders can use.

You may have heard the phrase "a basket of goods" in that basket are things like Milk, Bread, Clothing, Childcare, Petrol, Gas, Electricity and so on. All the things that are necessary to live for both adults and children.

The issue is the current position we all find ourselves in. That is the significantly increased costs of many items.

Gas and Electricity are rocketing and petrol is rising. As petrol rises so does the delivery cost of goods. I can go on and on but you get the idea.

As a result, the cost of that basket of goods the ONS uses to provide data has significantly increased. That increase is therefore represented by lenders when they apply the updated cost in their affordability calculations.

Nothing has changed here in terms of the lender's approach to affordability, it is simply the cost of the basket that usually increases by a small amount (inflation) each year. Not this year!

Lenders cannot avoid this, we all know how goods and services are skyrocketing so borrowers need to be able to demonstrate they can afford the higher cost of those goods and services.

When will it change?

Each lender will most likely have a specific time they will update their own models. For some it may be once a year regardless of when the ONS updates their data, for others, it may be as soon as the ONS provides an update.

Interest Rates add to the misery

Rising interest rates are also a factor. The Financial Conduct Authority states that all lenders must stress mortgages to ensure borrowers can afford the payments if rates rise sharply. To be fair that is what we are starting to see.

So even if your actual rate is 2% a lender may have a minimum stress rate at least 3% higher than that. I can recall stress rates at lenders being around the 5.29% mark a few short years ago. Currently, the stress rate is moving close to 7%.

Therefore new borrowers are having to deal with much higher spending costs and demonstrate they can afford a mortgage if the rate was 7%. If the rates continue to go up so will the stress rate.

The Financial Conduct Authority is currently reviewing stress rates, more on that here. But even if there is a positive to come, it will be too late for many.

The future

All I can really say is that it is going to worse and I suspect it will be some time before it gets better, assuming it does. I am always a glass half full type of person, unfortunately, it is difficult to maintain that in the current climate.

Genuinely feel for everyone struggling in this absolutely miserable period. I am feeling it and we are constantly looking at ways to save on costs at the moment.

Lee Wisener CeMAP, CeRER, CeFAP, CSME

Having worked in the mortgage industry for over 20 years I have always wanted to build a website dedicated to the subject. Also being a geek when it comes to the internet all I needed was time and I could both build the site from scratch and fill it with content. This is it!