When applying for a mortgage, one of the most crucial steps is understanding how lenders calculate how much you can borrow or how mortgage is calculated. Mortgage calculations are based on a range of factors, including income, outgoings, employment type, and deposit size. In this guide, I’ll break down the key elements that influence mortgage affordability, helping you to get a clearer picture of what you might be able to borrow.
How Mortgage Is Calculated: Debt-to-Household Income Ratio
Lenders assess how much of your monthly income is already committed to existing financial obligations. This is known as your debt-to-income ratio (DTI). It compares your total monthly outgoings such as loans, credit card payments, and essential living expenses against your monthly income. A high DTI can reduce the amount you can borrow, as lenders want to ensure you can comfortably afford your mortgage repayments without financial strain. Ideally, your total monthly debt commitments, including your new mortgage, should not exceed 40-45% of your income.
If you have a lot of loans, hire purchases, or outstanding credit card balances, you might want to look at reducing these commitments before applying for a new mortgage, as chances are that this will impact the amount you may be able to borrow.
Deposit Amount vs. Loan-to-Value (LTV)
The loan-to-value (LTV) ratio is another key factor in mortgage calculations. It represents the percentage of the property’s value that you need to borrow, based on your deposit size. The higher your deposit, the lower the LTV, and the more attractive the mortgage rates you are likely to receive.
For example:
- A 10% deposit means you’ll need a 90% LTV mortgage.
- A 20% deposit reduces your LTV to 80%, making you eligible for better rates.
- A 5% deposit means a 95% LTV mortgage, which may have stricter affordability assessments.
A lower LTV reduces risk for the lender, making it easier to secure a mortgage and potentially increasing the amount you can borrow.
Income Multiples: How Much Mortgage Can I Borrow?
Most lenders calculate how much they will lend based on a multiple of your income. Generally, you can expect to borrow between 4.5 to 5 times your annual income. Some lenders may go up to 5 times or even 5.5 times your income and in some rare scenarios above this, but this is typically reserved for high earners or borrowers with exceptionally strong financial profiles.
For example:
- If you earn £40,000 per year, you could potentially borrow roughly between £180,000 – £200,000.
- If you and your partner have a combined income of £70,000, your borrowing potential could be £315,000 – £350,000.
However, income multiples are just one part of the calculation and each calculation is different. Other financial commitments and the lender’s affordability criteria also play a role and you should always check your income multiple eligibility with your mortgage advisor.
Mortgage Term: How Long Can You Borrow For?
The length of your mortgage term affects both your monthly payments and your borrowing capacity. Most mortgages are taken out over 25 to 35 years, but some lenders offer terms up to 40 years.
- A longer mortgage term reduces monthly repayments, potentially allowing you to borrow more.
- Lenders will assess whether the mortgage term extends past your retirement age. If so, they may require proof of pension income or other post-retirement affordability checks.
- If you take a mortgage beyond age 70 or 75, lenders may be stricter with affordability assessments.
How Bonuses, Commission, and Overtime Are Considered
If you receive additional income from bonuses, commission, or overtime, lenders will assess whether this can be included in their calculations. Typically:
- Some lenders will count 100% of guaranteed bonuses but may only consider 50% of variable bonuses.
- Regular overtime may be included if you can demonstrate consistent earnings over the past 2-3 years.
- Commission-based income is usually assessed based on an average over recent years.
- Things like guaranteed car allowances are usually considered at 100%
Each lender has different policies, so it’s important to check how they assess additional earnings with your mortgage advisor.
Employment Type and Its Impact on Borrowing
Your employment status significantly affects mortgage calculations. Rightly or wrongly, mortgage lenders are definitely preferential to more straight-forward applicants. But of course, people earn money in lots of different ways in this day and age:
- Full-time permanent employment: Most straightforward for mortgage approvals. Generally lenders will only need 3 months payslips or perhaps a p60 to calculate any bonuses or extra income earned.
- Part-time or zero-hour contracts: Lenders may require at least 12 months’ worth of earnings evidence in the form of 12 months’ worth of payslips.
- Self-employed borrowers: Typically need 2-3 years of accounts if you are a limited company director or tax overviews and calculations if you are a sole trader, with lenders assessing an average of net profits or dividends.
- Freelancers and contractors: Some lenders use day rates multiplied by the number of working days per year.
Lenders prefer stability, so those with irregular income patterns may find borrowing more challenging.
Getting a Mortgage as a Self-Employed Borrower
If you are self-employed, lenders will base your mortgage affordability on your declared income. You’ll typically need:
- At least two years’ worth of tax returns (SA302s).
- Business accounts prepared by a qualified accountant.
- Some lenders may accept one year of accounts if you have a strong financial profile.
Self-employed borrowers often face stricter lending criteria, so it’s important to work with a mortgage broker who can find the best lender for your situation.
Additional Factors That Affect Mortgage Affordability
There are many things that COULD impact how mortgage is calculated, so that is why you should always be completely open and honest with your mortgage advisor about your current financial situation. Here are a couple of other elements that could impact how your mortgage eligibility is calculated:
- Credit score: A strong credit history can improve your mortgage options.
- Type of property: Lenders may have stricter rules for non-standard construction homes, new builds, or flats above commercial premises.
Speak to a Mortgage Expert
Understanding how mortgage affordability is calculated can be complex, as each lender has its own criteria. If you’re unsure how much you can borrow, speaking with a qualified mortgage advisor can help you navigate the process and secure the best deal for your circumstances. At Oportfolio Mortgages, our expert advisors can provide tailored advice and help you find out exactly how much you could borrow. Contact us today to discuss your mortgage options and take the next step towards owning your dream home.
