Money Corner: Mortgage Capacity from a Broker’s Perspective
Published: 03/07/2023 08:00
The last 12 months has seen substantial changes in the mortgage market, the products that are available and adjustments to the way in which lenders assess affordability for mortgages.
It has been widely reported that the interest rates on mortgages are currently at their highest level for 14 years, with the base rate now at 4.50% (at the time of writing).
With a whole generation of mortgage borrowers having only ever known ultra-low rates it is now more important than ever that people benefit from professional advice on their mortgage options. We have seen more people who may have previously gone it alone seek advice from independent services when it comes to their mortgage.
When it comes to affordability, rising interest rates and the increased cost of living have meant that lenders have tightened up the way that they assess affordability. However, alongside this there has also been a growing number of options available for borrowers, with an expansion of the types of income that can be used within this assessment in order to cover more complex structures, including the use of ‘unearned’ investment assets, something which was not available in previous years through High Street lenders.
Following the global financial crash in 2008 the emergency Bank of England base rate cut to 0.5% resulted in mortgage rates staying at an incredibly low level for over the last decade, with these products effectively reduced to 0% during the height of the COVID-19 pandemic. This was put into sharp reverse in the wake of the lockdowns and the ensuing inflation they created, with rates climbing sharply throughout 2022.
In terms of what is available in today’s market, there are quite a few options available below base rate; the best rate available at the time of writing is 3.87% fixed for 5 years – this compares to 0.99% fixed for 5 years which was available for a short time at the start of 2022. A remarkable turnaround.
Over the last 10 years it has been more common to see longer-term fixed rates priced higher than the shorter-term fixed rates, this is because during the period of low interest rates it was anticipated that the base rate would increase. Currently, we are seeing that shorter-term fixed rates are priced higher than the longer-term fixed rates, which shows us the market sees monetary policy being eased in the future.
With all of this in mind, attitudes to borrowing have shifted over the last 12 months. With the chaos created by the ‘mini budget’, lenders did not know where to price their products, and for a short time rates were sitting at 5.5%–6%, with many choosing to withdraw from the market entirely. At this point activity levels slowed to a standstill, with many people reluctant to look at buying, moving or taking out new mortgage debt.
Since the start of 2023 rates have steadily decreased with, as aforementioned, some options sitting below the bank of England base rate. Spring and autumn are notoriously busy periods for the property market, and while activity levels are lower than they have been in previous years, in certain pockets of the market there is still significant demand for good quality property in desirable locations. This, coupled with a general lack of stock has meant we have not seen higher rates impacting property prices as much as we anticipated in these areas. What we are seeing is that while borrowing with a rate starting with a 4 may feel like a large increase from 12 months ago, it is just about tolerable for many with stable employment (many of whom have seen wages increase over the same period) and those who are keen to move for lifestyle and family-based needs.
One area of the property market that has been significantly affected, not just by the rate increases but also by the changes in taxation, is the buy to let market. In a lot of cases, especially in the London market where yields are low, owning a rental property, with so many taxation and legislative changes alongside the huge costs of funding, it can end up costing money as opposed to generating revenue.
We used to see a lot of borrowers seeking what is called a ‘let to buy’ mortgage, where the owner looks to keep their first property and rent it out, releasing some of the equity to enable a larger onwards main residential purchase, something very popular in London. Since the introduction of additional stamp duty in 2014 when purchasing a second property, many who previously looked to execute this transaction decide to sell instead, as often the tax burden on the larger onward transaction made it financially unviable.
The changes in taxation have also affected the affordability of buy to let mortgages, meaning that high-rate taxpayers can borrow less money on rental properties owing to the increased tax that they will pay on the rental income. Some lenders reacted to this by bringing in an ‘overall affordability’ assessment, which means that people can use their own personal income to support a buy to let mortgage where the rental income is not enough to support the loan on its own. This has proved to be helpful in places where the rental yields are low, such as London and the South East.
One of the most asked queries that we field at the moment is whether to take a fixed rate mortgage product or whether to opt for something which is variable and potentially more flexible. There are varied predictions on the level at which interest rates will ‘peak’ and for people who have strong affordability and can tolerate the risk of a variable mortgage product over a 2-year period, that may work out as being a more cost-effective option with the market predicating the base rate to come down over the medium term. This decision on product would always come down to an individual assessment on a case-by-case basis for every single client.
It is very hard to put blanket ‘rules’ in place when it comes to assessing affordability on mortgages and every scenario has its own merits or disadvantages. One base way that lenders assess a potential maximum lending scenario is by using a simple income multiple. These limits vary from lender to lender, but the majority are between 4 to 5.5 times whatever income the bank will allow in the transaction. Maximum loan amounts also take into consideration loan to value ratio, type of property and credit profile, alongside level of personal income.
The next major factor in this lending decision is the day-to-day expenditure of the applicant. With more and more people having some level of personal debt, this can drastically affect mortgage affordability. Something we have seen increase during the cost-of-living crisis is borrowers missing payments on those commitments. Missed payments may mean that a lender will not accept a mortgage application or charge a higher interest rate. The credit file plays a huge role in a mortgage application being accepted, with lenders having their own internal scoring systems where they take all the client circumstances into consideration.
When talking about the types of income that we can use towards an affordability assessment there are lots of things that can be considered. Some of the more bespoke solutions that are available include the use of investment portfolios to underwrite the mortgage affordability where earned income is not sufficient to support the required loan amount; using retained profit within a business to allow a limited company director to boost their mortgage affordability; and solutions that allow friends and family to join an applicant on the mortgage to boost affordability. Generally, if you have no income there is no mortgage capacity; however, for people who are asset rich and income poor there may still be options from the retail banks, with their low costs and cheap rates.
Childcare and the cost of education can also have a significant impact on an individual’s ability to borrow and reforms in this area were central in the recent spring statement. In the United Kingdom children from the age of 3 receive 30 free hours per week of childcare, provided that not one of their parents is earning more than £100,000 per year. In the spring statement it was announced that the 30 hours of free childcare would be extended to all children from 9 months up to school age. This is coming in on a phased basis and by September 2024 all eligible children will receive the benefit. While the economic benefits are clear, we also think these reforms will have a very positive impact on mortgage affordability and the housing market in general.
Aside from the so called ‘Bank of Mum and Dad’, another way in which we see parents helping their children is by taking a mortgage with them on a joint borrower, sole proprietor basis. This structure means that the child retains their first-time buyer status for stamp duty purposes, but also allows parents to assist their children by supporting the mortgage with their income and not going onto the deeds of the property. This means that should the parent own their own property they would not become caught up in the second property stamp duty surcharge.
Continuing through the home-ownership lifecycle, at the other end of the scale many older people have benefitted from large increases in their property values. While this is great for their overall wealth, it does create some wider planning issues; they may want to gift money to their children, or they may need to supplement their retirement income. Taking a debt against their property can be a great tax planning tool as it creates a liability against the estate. Full financial planning advice can dovetail with our advice and, in these scenarios, we work closely with other professionals to fashion bespoke solutions for older borrowers. In later life we need to consider what we will be leaving behind and how we can protect the wealth we have created for the future generations of our families.
Equity release or Lifetime mortgages have had a bad reputation in the past; however, in the modern mortgage market borrowers are awarded more flexibility and protection with this type of lending than ever before. With the introduction of the equity release council, which most lenders are a part of, borrowers enjoy a no negative equity guarantee, downsizing protection and the option to repay parts of the loan.
In terms of affordability, equity release does not look at income in the assessment of what can be borrowed, with lending decisions all based on age and life expectancy of the borrower alongside the value of the security property.
There are many occasions through life where a mortgage advisor can be helpful and provide a professional and thoughtful service. We are completely independent and can analyse the whole market for clients in so many different scenarios. We are there for our clients during those tricky times in life, such as divorce and providing their mortgage capacity, or the joyful moments, such as helping children to buy their first home.
People are always looking for the ‘right time’ based on the market and interest rates, and while these are incredibly important in relation to making good decisions, it is also important to do what is right for your individual circumstances.
Looking ahead to the second half of 2023, I think we will see rates hold for a little while longer, and potentially start to come down towards the end of the year. We have the first-time buyer stamp duty reverting back to where it was pre-mini budget in the spring of next year, but it will be interesting to see what new initiatives the government has in order to help people into home ownership.