Forget area, neighbours, bathroom colour and local school Ofsted reports. The very first thing you need to ask yourself when buying a property is ‘how much mortgage can I afford?’.
With the average UK house price currently standing at £215,000[i] this is probably one of the biggest purchases you’ll ever make so needs to be very carefully considered.
Not just in terms of the total value, but as the monthly payments you’ll need to make to keep your mortgage lender happy. Unless you’ve bought your property outright, you’ll almost certainly need to borrow to buy, and it makes sense to work backwards by calculating the monthly amount you’d be comfortable paying, then using this to find out the amount you could borrow
A (very) brief history of interest rates
The interest rate in Britain currently stands at a record low of 0.25%. That’s the smallest it’s been since the Bank of England first opened its doors in 1694. Great news for borrowers as that means the interest rate you pay on your mortgage – topped up by your lender, of course – is also at a record low. But what goes down can also go up. Remember when it was 12% in 1992 or a whopping 17% in 1979? Maybe not, but it pays to take a short history lesson before leaping in to see how an interest rate change would affect your monthly payments. Though we’re unlikely to see a major hike in the near future, the rate could creep up gradually over the term of a 25-year mortgage. For example, if you are paying roughly £765 per month on a £200,000 mortgage at 1% today (over 25 years), that would rise to £1,182 at 5% – and balloon to a sweat-inducing £2,125 per month at 1992’s rate of 12%.[ii]
The importance of your deposit
The deposit, typically 17%, is what you pay upfront when you take out a mortgage. To get you a mortgage on the average UK property priced at around £215,000, that would weigh in at a hefty £36,550. You can always go for a smaller deposit by taking up one of the many mortgages available with 10% or 5% deposits, but these often burden you with higher fees and interest rates. So if you’re a savvy mover, you’ll try and pay the largest deposit you can afford to save in the long term.
Don’t forget fees, Stamp Duty and other costs
You didn’t really think your hard-saved cash would only be reserved for your deposit did you? Of course not. When you’re doing your sums, don’t forget to factor in the extra costs that people often overlook until they receive an invoice. Things like mortgage fees that can be up to £2000 and legal costs that are typically £850-£1,500 (including VAT at 20%); plus stamp duty that’s payable to the Government when you purchase a residential property in England worth more than £125,000. This final expense can often catch buyers out. The calculation is based on a few different factors, but for the sake of example, will stand at around £1,500 on a £200,000 property purchased in January 2017. All in all, extra expenses that could add an extra £5,000 to the price of your property purchase.
2014 Mortgage Market Review
Gone are the days when lenders would approve mortgages without being too stringent with their checks and criteria. This practice was deemed to be partly responsible for the recent global banking crisis, so the powers that be introduced new measures to make things a little more difficult. The 2014 Mortgage Market Review (MMR) puts the onus on banks and building societies to ensure their customers can afford to repay their mortgages and has introduced more hoops for borrowers to jump through.
Shared ownership/Shared equity
The Government Help to Buy scheme offers you the chance to buy a share of your home (between 25% and 75% of the home’s value) if you can’t afford the total amount or get help with an interest-free loan or savings top up.
You can buy a home through Help to Buy: Shared Ownership in England if your household earns £80,000 a year or less outside London, or your household earns £90,000 a year or less in London. The scheme can also help first-time buyers, those who used to own a home but can’t afford to buy one now or are existing shared owners looking to move.[iii]
What lenders look for
Lenders examine 5 main factors when considering your mortgage application. Often referred to as the 5 Cs, these cover: Character – stability, such as how long you’ve lived at your current address etc; Capacity – your other debts and expenses when deciding if you can afford your mortgage payments. Capital – how much money you have, worked out by the value of your assets. Collateral – any asset such as your home that they can take ownership of and use to pay the debt if you can’t afford to pay your mortgage. Conditions – they also look at outside circumstances that may affect your mortgage, such as the local housing market and economic forecasts.
Your credit score and how to improve it
Lenders always check your credit score to help them make a decision. The good news is, it’s easy to find out what they know about you and take steps to improve your rating if necessary. You can normally check the information for free held on you by the main credit referencing agencies either by applying direct at: Experian, Equifax and CallCredit, or using a free service such as Clearscore to see how you measure up. If you need to improve your score, steps like ensuring you are on the electoral roll can help boost that all-important figure.
Next step: Getting a Mortgage