Mortgage Income Multiples

Did mortgage income multiples really get too high?

Is anything over 3.5x salary too much?
If you believe the press then the answer is yes. Cast your mind back to the late 80's / early 90s when interest rates hit 15% and lenders were still offering 3.5x income multiples.

For comparision our fictional £100,000 mortgage (over 25 years) would cost:
Capital Repayment @ 5%: £584.59
Capital Repayment @ 15%: £1280.83

What the press fails to report

Generally the general media quote income multiples but fail to explain that most lenders work on affordability.
What does this mean? Well the lender looks at your income and your outgoings (including the proposed mortgage payment) and sees if this fits their criteria. This metric is normal expressed as a ratio of "debt to income".

For someone with a £500 mortgage, £100 loan commitment, £200 council tax and a monthly (gross) income of £2000 their debt to income ratio would be:
500 + 100 + 200 / 2000 = 0.4 or 40% debt to income

The debt to income or affordability calculation is a much better way for lenders to determine what level of borrowing an applicant can support. In general the costs for council tax / food shopping / loans are not significantly more expensive for someone who earns £100,000 p.a. over someone who earns £10,000 pa.

Lets compare a couple of examples Note: I have used 5% as a standard interest rate in all calculations and the calculations have been simplified for brevity..

£10,000 income - 3.5x income
Maximum mortgage borrowing = £35,000 = £204.61 monthly
Council Tax: £100
Food Shopping: £200

Total debt to income: 66.6%
Disposable income: £278.72 (before tax and national insurance)

£100,000 income - 6x income
Maximum mortgage borrowing £600,000 = £3507.54 monthly
Council Tax: £300
Food Shopping: £500

Total debt to income: 51.7%
Disposable income: £4025.79

Personally I wouldn't advise either of these clients to borrow to this level, but it demonstrates the concepts of affordability. You would certainly say that 5x income multiple could be fine for the applicant on £100,000, but the applicant on £10,000 should probably be on something closer to 2.5x.

It is no longer sufficient for lenders to use a "one size fits all" income multiple. To ensure that they are lending responsibly they need to look at each applicants affordability.

This is a good thing. Borrowers with lower commitments should be able to borrow more - its just good sense, or as Gordon Brown would say "prudent".