UK mortgage affordability rules explained

Mortgages are private loans, but the Financial Conduct Authority (FCA) and the Bank of England (BOE) regulate the banks and building societies who lend them. So while affordability rules vary from lender to lender, they often follow the same practices.

If you're thinking about taking that first step on the property ladder, it's important to get acquainted with the rules associated with mortgages. In this article, we take you through mortgage lending criteria and the new rules regarding mortgage repayments and interest rates.

What are UK mortgage affordability rules?

Rules vary from lender to lender, but the general consensus is that borrowers can receive up to four or five times the size of their salary as long as certain criteria are met. These usually consist of:

1. An excellent credit score

The better your credit score, the better your chance of being approved for your mortgage. The quality of your mortgage package also improves with the strength of your score.

Issues like late payments or ongoing debts can impact the amount you can borrow. It's important to pay off all your debts before you apply or remortgage.

If you have a history of bankruptcy, some lenders will disregard your application completely. There are mortgage brokers available who can help you navigate through this situation.

We always recommend instructing a broker to help you locate the best deal for your application.

2. Employment and income suitable for projected interest repayments.

Stable employment and sustainable income are necessary for mortgage approval. Lenders want proof that you'll be earning enough every month to make mortgage payments on-time and in-full.

Another thing that affects your mortgage approval is your employment status. If you are self-employed or receive income from multiple sources, your lender may need further details to decide what's included in their affordability assessment.

Self-employed workers don't always earn the same amount each year, making it difficult for lenders to guarantee them the highest possible loan.

3. Average spending in line with what they consider responsible for a borrower.

Lenders also assess your regular spending habits to work out whether you are a reliable borrower. They may do this by either requesting bank statements from your account, or by asking you to fill out a budget form.

As long as you are within budget and have no debt, you should be okay. However, if it's your first time applying for a mortgage, it might be worth keeping your spending low for six months before beginning the application process.

4. The value of the property is the same as marketed.

To ensure their loan is covered, lenders secure your house as collateral - which is why the value of the property must be identical to what's described in the application. To verify its value, lenders send agents to confirm its market price.

Properties found to be overvalued or undervalued can cause applications to fall through.

Example: You request a loan of £270,000 for a house worth £300,000. The lender sends an agent round and the agent reveals the house is overvalued at £250,000.

Your mortgage lender is hesitant about financing the purchase because they might not receive the same amount of money if they resell the house.

As a result, the lender states that they will not finance the purchase unless the homeseller is willing to reduce the selling price of the property. The seller refuses and your property purchase falls through.

When you remortgage...

Things work a little differently. If you already own a house but move to a new deal with the same lender, you might be able to skip some of the initial affordability tests. Lenders are encouraged to treat their existing customers fairly, and it's in their best interests to keep you on side.

If you intend to switch lenders for a better fixed rate however, you’ll need to go through the same rigorous application process you went through the first time.

What happens if my mortgage application is rejected?

Your lender’s underwriter saw something they didn’t like when processing your application. Your first point of call is to ask what?

There could be several reasons: their credit reference agency may have an issue with your credit report, or the property you want to buy may have been overvalued. Whatever the reason, you need to fix it - and wait at least six months before applying again.

But why do you need to wait six months? Every mortgage application comes with a hard credit check. Lenders can see hard credit checks on your report, and multiple hard checks in close proximity suggest that you are an untrustworthy borrower.

It may not be ideal, but you should pad out the time between applications by full-proofing your credit report.

Loan to Value Ratio (LTV)

Your Loan to Value Ratio is the percentage of the total value of the property that you borrow from your mortgage provider:

Example: Buyer seeks a £200,000 property. Borrows £180,000 from a lender with a deposit of £20,000. LTV = 90%.

As you pay back your mortgage - and the amount of the property you own outright increases - your LTV decreases. Homeowners who have paid back a lot of their loan have low LTVs, and find it easier to get better deals when they remortgage.

If house prices increase in value, your LTV takes this into account:

Example: Your £200,000 property increases by 10% to £220,000. You now own the initial £20,000 deposit plus the extra £20,000. This is known as equity, and your LTV is now 78%, with the bank owning £180,000 to your £40,000.

Conversely, if interest rates increase with the Bank of England base rate - but house prices decrease - homeowners could find themselves in negative equity. This is when your property is worth less than the outstanding value of your mortgage.

If you ever find yourself in this position, but can still afford mortgage payments, your best bet is to hold tight - continue paying and wait until prices increase.

If you find that you cannot afford mortgage payments, contact your lender and see if they can arrange a different payment plan.

Why are there affordability rules?

Mortgage lenders are businesses. They want to secure an income for as long as possible - but they must also compete with other banks to provide loans that borrowers find attractive and fair.

So affordability rules, such as having an excellent credit score and an appropriate income, are there to ensure that you can afford to repay the loan, and its accumulated interest, for as long as possible.

Secondly, the Financial Conduct Authority requires that lenders use some kind of mortgage affordability rule to prevent customers from being unfairly treated.

The FCA is a regulatory body that exists to:

• Ensure the fair treatment of customers
• Maintain healthy competition
• Stabilise the UK financial system.

As we've said already, the consequences of a defaulted loan can be severe. You can lose your house, belongings and credit score. A damaged credit rating can stop you from taking out a loan again, diminishing the likelihood of future property ownership.

To prevent customers from facing the harsh consequences of a defaulted loan that wasn't fair to begin with, the FCA regulates banks and building societies on business responsible lending rules.

Mortgage affordability test changes - August 2022

Since 2014, the Bank of England has required that lenders test potential borrowers on their ability to make repayments - specifically under scenarios where interest rates rose by 3%. In a move to offset the Cost of Living Crisis in August 2022, the BOE announced that the stress test was no longer a requirement.

What does this mean for borrowers?

Borrowers may be able to take out larger mortgages despite falling short on the affordability test. Nevertheless, they must still meet FCA affordability tests. Residential loans are unlikely to exceed the four to five times salary rule.

How to improve your chances of being accepted

If you're thinking of applying for a mortgage, it's in your best interest to prepare for your lender’s rigorous credit checks. Clear any debt you have, make bill payments on time, and build up your credit score.

One of the best things you can do before submitting your mortgage application is take out a mortgage agreement in principle (AIP). With an AIP, you’ll get a good idea of whether your actual application will be accepted or not. This assurance can make the process much less stressful - but be warned, sometimes an application can be rejected even with an AIP.