What a lot of aspiring homeowners and borrowers don’t know, is that there’s a lot more to a lender’s assessment of you than your credit score and income. In this week’s blog post, we’ll take a deeper dive into a lender’s assessment of borrowers, which we introduced a couple ofweeks ago in this post, by diving into 3 specific criteria that mortgage providers use when determining an applicant’s suitability to borrow: debt-to-income (DTI) ratio, gross income multiplier and loan-to-value (LTV). We’ll also explore how these work together for lenders to determine your affordability limits.
Debt-to-income ratios
The DTI ratio is defined as the borrower's monthly debt payments in comparison to their monthly income. This is a quick way for mortgage providers to assess a borrower's ability to repay their mortgage. It’s typically calculated as: total monthly debt payments ÷ total gross monthly income.
A higher DTI ratio indicates that the borrower may be financially stretched and already using too much debt. This means that mortgage providers believe there’s a higher chance that you will default on your mortgage payments and other debts. Conversely, a low DTI ratio may indicate that you have more financial capacity to repay your debts than what you’ve borrowed to-date.
In Britain, most lenders prefer a DTI ratio of no more than 43%. However, it’s key to note that as with any credit metric, DTI is just one of the metrics that lenders use and that the overall level of tolerance for an individuals DTI ratio depends also on their credit score and their credit history.
Gross income multipliers
Gross income multipliers are used by mortgage providers to determine the total amount that an aspiring homeowner can borrow based on their gross annual income. A borrower’s gross annual income is what they earn before the deduction of any taxes, on which lenders apply a pre-determined multiplier. Sometimes, lenders take bonuses and overtime pay into consideration as well, when applying the multiplier (however their treatment of these can vary by lender). These are impacted as well by the FCA's 15% loan book rule
The multipliers that lenders apply depends on the state of the overall economy and housing market, as well as the borrower’s personal circumstance. In times of robust economic outlook, lenders tend to be more comfortable at higher multipliers. Today, most lenders impose a maximum of 4.5x (so someone earning £30,000 may be able to borrow £135,000). There are some mortgage products, often targeted at first-time-buyers, that allow multipliers as high as 5.5x, however these are typically reserved for higher earners or those with stellar credit histories.
Loan-to-value ratios
As the name suggests, loan-to-value measures the total size of the mortgage compared to the value of the property that is being purchased. It’s typically represented as a percentage and is calculated based on the loan amount divided by the property value. For example, if a borrower is applying for a mortgage of £150,000 to purchase a property worth £200,000, the LTV would be 75% (150,000 ÷200,000 x 100). A higher LTV implies that there’s less of the buyer’s equity being used to make the purchase, which means that the lender is taking a higher risk and will likely charge a higher interest rate.
LTV ratios crucially determine how much of a deposit you need as an aspiring homeowner. If a property is worth £200,000 and the lender requires a minimum deposit of 10%, or £20,000, this implies a 90% LTV. Until recently, there were 95% LTV mortgage products readily available, supported by the governments Help-to-Buy scheme. However, since the discontinuation of that scheme and the weakening of the economy, a lot of lenders have withdrawn their 95% LTV products and instead offer 90% LTV as a maximum.
How do they all work together?
Sometimes looking at one metric singularly can be misleading. Let’s take the example of a borrower, earning £35,000, who is looking to buy a home listed at £200,000 and finds a mortgage lender that offers a 90% LTV mortgage product. This might lead the borrower to believe that they can borrow £180,000 of the purchase price. However, £180,000 represents an over 5x multiple on their income, which exceeds the maximum that most lenders will allow of 4.5x. In practise, this means that theborrower may be forced to either find a cheaper property or place a larger deposit to afford this home.
The lender's actual mortgage offer to the borrower in our example may decrease further if it turns out that the borrower has other outstanding debt repayments, such as a credit card balance. That could impair their DTI ratio, resulting in a lower maximum mortgage amount.
These factors combined make getting a mortgage confusing and can complicate a first-time buyers homeownership aspirations. That’s why it’s important for inexperienced buyers to consult a mortgage adviser to ensure that they’re finding products suitable to their financial circumstance.
How does Jrny look at these ratios?
Similar to a lender, these ratios do impact your budget with Jrny. Unlike a lender, we’ve designed our limits to ensure that your dream home remains within reach. At the end of the lease, if you can’t get a mortgage, you can choose to cash out the equity in your Jrny Wallet at full value, or you can extend the lease to build more equity. Contact us at @ info@joinjrny.com to find out more.
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