Your borrowing capacity will depend on several factors that affect your home-buying options
Buying a home is one of the most significant financial decisions many of us will make. However, before you start arranging viewings or envisioning where your furniture will go, it’s essential to determine how much you can realistically afford to borrow for a mortgage without overstretching your finances. Your borrowing capacity will depend on various factors that influence your home-buying options and impact your financial security in the long run.
Understanding your financial capacity requires thoroughly examining your income, expenses, and personal circumstances. Lenders use this information to assess your financial standing, aiming to ensure that mortgage repayments remain manageable over the long term.
What lenders take into account
Before approving your mortgage application, lenders require reassurance that you can comfortably meet your monthly repayments. They typically start by examining your income from various sources, including your salary, bonuses, dividends, investment returns, and government benefits. For example, if you earn a salary of £50,000 per year and also receive an annual £5,000 in bonuses, lenders are likely to factor both into their assessments, provided there is a consistent history of those bonus payments.
Debt and outgoing expenses are equally important. Lenders will carefully review your monthly expenditures, including essential bills, groceries, loan repayments, childcare costs, and subscriptions. This assessment is referred to as your debt-to-income (DTI) ratio. For example, if your monthly income is £3,000 after tax and your expenses total £1,500, your DTI stands at 50%, which some lenders might view as high. Ideally, lenders prefer a DTI ratio below 40%, ensuring you have enough buffer for unexpected financial challenges.
How much deposit do you need?
The deposit you can put down significantly influences how much you can borrow and the terms that lenders will offer. Typically, deposits range from 5% to 20% of the property’s purchase price. For instance, if you are considering a property priced at £200,000, a 5% deposit would amount to £10,000, while a healthier 20% would require £ 40,000.
The size of your deposit often influences the interest rate you’re offered. A larger deposit lowers your loan-to-value (LTV) ratio, making your application appear less risky to lenders. For instance, with a £40,000 deposit on a £200,000 property, your LTV would be 80%. This lower LTV not only makes you eligible for better interest rates but also reduces your overall repayment amounts.
Saving for a larger deposit may seem daunting, but it can significantly lower your monthly payments. For example, over a 25-year term at an interest rate of 2.5%, borrowing £180,000 instead of £190,000 can save you thousands in interest.
Can you get a mortgage without a deposit?
For prospective buyers who struggle to save, a no-deposit mortgage may seem like a convenient shortcut. Some lenders offer 100% mortgages, meaning you don’t need a deposit at all. However, these loans often come with stricter conditions. For example, lenders typically require a guarantor, such as a parent or close relative, to commit to covering the mortgage payments if you fail to do so.
Schemes like Shared Ownership and the Mortgage Guarantee Scheme may also provide options for buyers with smaller deposits. For instance, under Shared Ownership, you could purchase a share of a property (e.g., 25-75%) while paying rent on the remaining portion. This could mean needing only a 5% deposit on a £100,000 share of a £250,000 property, totalling £5,000 instead of £12,500 if buying outright. However, these arrangements come with their own financial commitments, such as rent and service charges, so it’s essential to evaluate them carefully.
How much can you afford?
The biggest factor in understanding how much you can afford to borrow is your financial profile. Typically, lenders allow you to borrow between 4 and 4.5 times your income, though some may offer more. For instance, with a combined household income of £60,000, you could potentially borrow between £240,000 and £270,000. However, significant debt or a low credit score could reduce this amount.
Using mortgage affordability calculators can help you estimate borrowing limits. For example, inputting an income of £40,000, monthly expenses of £800, and a deposit of £20,000 into a mortgage calculator might show you can borrow a maximum of £160,000. These tools provide a useful starting point but don’t replace advice tailored to your unique circumstances.
When planning your mortgage repayments, always account for interest rates and potential increases over time. Opting for a fixed-rate mortgage ensures your monthly payments remain stable, which may be helpful if you’re working within a strict budget.
Borrowing if you’re self-employed
The self-employed often face more stringent requirements when applying for a mortgage, but that doesn’t mean homeownership is out of reach. Lenders commonly request two to three years of income evidence, such as SA302 forms from HMRC or professionally prepared accounts. For instance, if your business brings in an annual income of £50,000, an accountant-certified report could reassure lenders that you’re financially stable.
To strengthen your chances, ensure your financial records and tax returns are accurate and up to date. Additionally, saving a larger deposit can make your application more appealing. Some lenders also consider retained profits in limited companies when calculating income, so seeking advice from a broker with expertise in self-employed applications can be invaluable.
Taking the next steps
Calculating how much you can afford to borrow requires careful planning and a clear view of your financial situation. Scenarios like a growing family or transitioning from renting to buying call for different approaches. Whether you’re navigating the complexities of being self-employed or weighing your deposit options, the right mortgage is out there for you.
For tailored advice and personalised guidance, consider consulting a mortgage advisor. They will not only simplify the process but also match you with the right lenders for your specific needs. Contact one today to take that next step closer to owning your dream property.
