Assessing the affordability of a high LTV mortgage

For example, Mr Murphy says they need to determine if they are considering buying a new home whether they are comfortable with having to repay a share of the value of any increase in the property if and when they come to sell it, as they would under the shared equity Help to Buy option.

If they are using the shared equity scheme, Mr Murphy says people will also need to determine that they are comfortable in the future, usually after five years, to start ‘staircasing’ out of the shared equity element and the additional costs that they will potentially need to take on to do this.

Repayments start in year six at 1.75 per cent and then ratchet up at RPI inflation plus 1 per cent thereafter. The flip side is that the core mortgage repayments will be lower on what is only a 75 per cent LTV mortgage.

The Help to Buy Mortgage Guarantee scheme is in contrast a conventional 95 per cent LTV mortgage and interest rates charged reflect this. Typically fixed for two to five years, rates are currently around or modestly above 5 per cent.

Under new Mortgage Market Review rules, all of this will be taken into account, and affordability ultimately determined by, the lender, with all sales processes now deemed as ‘advised’ and a borader view of income plus the impact of rate changes needing to be considered.

There is obviously a risk that many of the sorts of buyers that are being targeted by the schemes will be precluded from borrowing on an affordability basis under the new rules.

Mr Murphy says: “The majority of lenders have been assessing a borrower’s ability to afford a mortgage by thoroughly understanding the nature and level of their income, whether they are employed, self-employed, have elements of their income that are variable of guaranteed.

“This could be performance related pay including bonus, commission, profit related, based upon number of hours worked.

“A lender will then want to understand that borrowers’ expenditure and these income and expenditure can range between the quite high levels to the extremely detailed.

“Typically a lender will want to understand how much of the potential borrowers income they spend on committed aspects like utilities, household expenditure including food, insurances, pension contributions, travel expenses... child care costs... existing loans and credit commitments, and the more discretionary expenditure on leisure activities, etc.

“The lender will thoroughly assess the income and expenditure and their affordability models will determine whether or not a potential borrower can afford the mortgage today and in the future by stress testing that borrower’s income and expenditure against a potential future interest rate rise.

“For those who are borrowing at a higher LTV, the mortgage will generally represent a higher percentage of the borrower’s disposable income and so lenders will typically be more cautious.”