Need a mortgage? New rules mean you'll have to ditch all those little extras

http://www.theguardian.com/money/2014/apr/12/need-mortgage-new-rules-lenders-check

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Thinking of taking out a mortgage in the next few months? Then start living like a monk now. Home loan experts are advising would-be borrowers to pay off debts and cut right back on their spending for at least three months before applying for a mortgage.

That could mean cutting back on the "extras" that show up on a bank statement – which means ditching nights out and takeaways and forgoing other luxuries. These could include regular payments to streaming services such as Netflix and Spotify, purchases of music and apps, and subscriptions to online games, magazines, wine clubs and so on.

Childcare costs will also become a major element in testing how much borrowers can afford.

The reason wannabe homebuyers are being urged to stay in with a TV dinner and keep their bank card locked away is strict new rules on mortgage affordability come into force on 26 April which will see banks and building societies going through bank statements with a fine-tooth comb.

You will need to show the lender you are financially healthy and can afford the repayments. There may not be much you can do about some of your outgoings, but if there are areas where you can rein in spending, start doing it now.

The big winners from this shake-up look like being those whose finances are in tip-top condition – ie, they have a squeaky-clean credit record, are not heavily weighed down with bills and other commitments, and tend to have a decent amount left over each month which they put into savings or leave sitting in their bank account.

Brokers say they will be able to borrow up to five times their salary – and that applies to couples, as well as single applicants. So a single person earning £35,000 a year may be able to borrow up to £175,000, while for a couple who each earn that amount, it could be as much as £350,000.

Some reports circulating in the mortgage trade press suggest that despite the "clampdown", designed to prevent a return to the dodgy practices and unsustainable borrowing seen in the run-up to the financial crash, some people will qualify for loans equal to seven or eight times their income.

Rob Killeen at mortgage broker Capital Fortune said it was potentially possible that someone earning £100,000 a year, who lives a very frugal lifestyle – no dependants, cycles to work, doesn't take holidays, grows their own veg, no commitments such as gym membership – could borrow as much as £700,000 or £800,000.

Others will lose out. Some applicants with young children may find they can borrow a lot less than they expected. That's because under the old rules outgoings such as childcare costs were ignored by some lenders when they assessed applications – but under the new regime these will now be taken into account. With childcare representing a huge financial burden on many, it will be interesting to see how people find ways to play the system to max out their borrowing.

Will couples about to apply for a mortgage but weighed down by costly nursery/childminder/after-school club fees attempt to get their costs down by begging a friend or relative to help with their childcare for a few months?

Will couples planning to have children quite soon tell the adviser at the bank: "No, we're definitely not planning to have kids for a very long time?"

How will lenders and brokers police this system – if they think someone is lying will they try to find evidence that they recently bought a pregnancy testing kit, or hire paparazzi to take long lens photos of people furtively visiting their local Mothercare?

Under the new rules borrowers will have to go through tougher checks and show they can still afford to make monthly repayments on their loan if interest rates leap up.

The changes follow the City regulator's "mortgage market review" (MMR), and will involve some borrowers having to answer 40 or more "lifestyle" questions before obtaining a loan.

Go back a few years and the traditional "income multiple" – a key element in deciding how much someone could borrow – would be three to 3.5 times a single income, or 2.5 to 2.75 times joint incomes. But then they started creeping up, with lenders justifying this by saying that bigger loans were the only way to bridge the huge gap between house prices and earnings.

Income multiples have not been abandoned as part of the latest shake-up – they are still in the mix, alongside the affordability checks and credit-scoring.

Warnings have already been issued that these checks could translate into long grillings and intrusive questions about spending.

Last week a report in trade publication Mortgage Strategy stated that a manager at "one of the UK's biggest lenders" had claimed customers could expect waiting times of up to a month for an appointment with an in-branch mortgage adviser, and that these face-to-face meetings could take between three and three-and-a-half hours from 26 April. The article said that, according to brokers, these meetings should not normally take more than an hour.

If high street banks and building societies do end up struggling to cope, and the fears of long waits for an appointment and lengthy interrogations from overly cautious branch staff become a reality, this could be good news for brokers. They are likely to argue they are better placed to cut through the bureaucracy and make the process less painful.

Jonathan Harris, director of mortgage broker Anderson Harris, says that under the old rules the borrower declared their outgoings and the lender took a cursory look at their bank statements (typically you need to provide your last three months' worth). "Now, the bank is likely to go through them with a fine-tooth comb," he adds.

Harris says that as part of this process, the lender will take into account items that, in many cases, it wouldn't previously have viewed as a commitment. "These could be anything from pet or dental insurance to gambling [payments] or direct debits to wine companies.

"Our advice is to cut back for three months before applying for a mortgage: pay off debts and simply spend less. In the past, borrowers reined back their spending once they had a mortgage and had to pay it each month. Now you should act as though you already have that commitment, and reduce your spending accordingly."

Gavin Littlejohn, founder of the Money Dashboard website, says borrowers can prepare for the new regime "by properly budgeting and showing consistent behaviour of being able to live within their means".

Its research suggests some people have plenty of discretionary spending they can cut back on. It looked at the expenditure patterns of 20,000 people who use the service, and found that those who buy music spend an average of £12 a month, while those who indulge in takeaways typically spend £37 a month on them.

Smokers spend an average of £47 a month on their habit, while those who go to concerts/the theatre or who regularly eat out/go drinking typically fork out £99 and £89 per month on these respectively.

Crunching the affordability figures

Guardian Money did its own detailed research using an affordability calculator that mortgage brokers can use to find out how much Santander will lend their potential clients. Our findings suggest that couples, where both adults are earning and who have no children, are big winners.

They also show a definite link between things such as spending on going out and holidays, and how much you may be able to borrow.

Single person on £35,000 a year with no children and a £20,000 deposit

We assumed they are about to turn 35; are in permanent employment, with no other sources of income, and have an outstanding credit card balance of £1,000, but no other credit commitments. We also assumed they want a 25-year repayment mortgage.

We factored in a £120 a month salary deduction into their pension, and a £100 per month payment to their credit card provider, plus these monthly costs: £250 on food, drink and clothing; £30 on household goods and services; £60 on utilities and council tax; £250 on transport (we assumed a £3,000 annual rail season ticket); £75 on holidays; £75 on entertainment and recreation; and £50 on "miscellaneous goods and services".

According to the Santander calculator, our singleton could borrow £140,000 if they achieved a "medium" or "high" credit score, and £126,900 if they could only manage a "low" score.

But what if we tweak a few of the numbers to make our singleton just a little bit more financially irresponsible? When we upped the outstanding credit card balance to £5,000 and increased monthly spending on holidays and entertainment and recreation to £150 and £200 respectively, but kept everything else the same, the amount they could borrow if they achieved a medium or high credit score fell to £130,500, and to £120,400 if they achieved a low score.

Couple who each earn £35,000 a year, putting down a £20,000 deposit

First, we looked at what would happen if we said they had no children. We used all the same assumptions as in the example above, except based on two people instead of one. The calculator said they could borrow £325,900 provided they achieved a medium or high credit score, or £280,000 if they achieved a low score.

Then we tweaked some of the numbers. We gave our couple two young kids who are both in full-time childcare, resulting in a hefty £11,700 annual bill (the average yearly bill, based on a two-year-old who goes to nursery for 42 hours a week, and a five-year-old in an after-school club, according to the Family and Childcare Trust), which works out at £975 of fees to pay per month. We also upped the food, drink and clothing costs, to a total of £600 a month, and included the £1,752 of child benefit per year our couple are entitled to (they are not entitled to any tax credits).

That huge childcare bill massively pushed down the amount they could borrow – to, at most, £205,600, which assumes they achieve a high or medium credit score. If they only manage a low credit score, the figure is just £169,200 – little more than half the amount the "cleanest" borrowers can obtain.

Our research broadly chimes with findings by mortgage broker Anderson Harris, which gave us some broad estimates of what they expect could be achieved. It said a couple with no kids, both earning £35,000 a year, could qualify for a loan of up to £350,000, assuming they met all the criteria on affordability, credit scoring etc. Give them two young children and that would fall to £159,000 if you assumed a lower credit score and factored in £500 per child per month of childcare.

What happens when rates rise

Would you be able to afford your monthly mortgage payments if you were hit with perhaps a dozen or more 0.25% interest rate rises? That is one of the questions people may have to ask themselves – and that may well be asked of them – as part of this month's home loans shake-up.

One key part of the new regime is the "stress testing" lenders will carry out to try to establish whether people will still be able to manage their repayments if and when interest rates eventually rise.

So what assumptions will banks and building societies use? Many are playing their cards close to their chests but, in general, lenders seem to be applying a "stress rate" of between 6% and 7%, says Peter Gettins at mortgage broker London & Country. For example, Barclays' mortgage arm, the Woolwich, has said it will test affordability by applying a 6.74% rate. (The rate that will be used for its Family Springboard deal and Help to Buy mortgage guarantee applications is higher at 7.49%.)

In other words, the deal you are applying for might have an initial rate of 3% or 4% now, but the lender will want to know that you could afford payments if it were 6.74%. If you borrowed £200,000, and took out the Woolwich's 2.79% two-year fix, your initial payment would be £927 a month, but at 6.74% the monthly payment would be £1,381, assuming it is a 25-year repayment loan.

Perhaps surprisingly, City regulator the Financial Conduct Authority (FCA) isn't being prescriptive about how banks and building societies should handle this. It has indicated it wants them to take into account market expectations of Bank of England base rate movements during the first five years of the loan. The FCA is "suggesting" lenders might want to use the so-called forward sterling rate published on the Bank of England's website every day, which on Wednesday this week was suggesting interest rates may rise by 3.19% over the next five years (a few days earlier the figure quoted was 3.29%).

Most experts typically take the view that the base rate will rise from its current all-time low of 0.5% but won't go back to the 5%-plus levels seen in 2006-08.

The Bank is expected to leave rates at 0.5% until spring 2015, although governor Mark Carney has said a rise before next year's election can't be ruled out.