The rapid rise in mortgage rates over the past year has dramatically reduced the amount that people can borrow based on the same monthly payments.
The size of mortgage that a £1,200 monthly payment secures now with average rates above 5 per cent is much smaller than when rates averaged about 2.5 per cent.
What are the implications of this and how big a mortgage could you get now? Ed Magnus takes a look.
Higher rates cut mortgage sums people can afford
More than 1.4 million UK households face the prospect of interest rate rises when their fixed-rate mortgages come to an end this year, according to ONS data.
It estimates that 57 per cent of those with fixed mortgages ending in 2023 are currently fixed at interest rates below 2 per cent.
If they took out a new mortgage at today’s 5 per cent-plus average rates – whether that is to move home or remortgage – they would be paying more than twice the interest they were before.
It means that people cannot borrow as much money as they could for the same monthly payment.
Take this example. Someone, who could previously afford a £200,000 mortgage repaid over a 25 year term at a 2 per cent rate may no longer be able to afford a £200,000 mortgage at 5 per cent.
That’s because the monthly cost will now set them back £1,169, as opposed to £848.
If they cannot afford to pay any more than that £848 each month, they will now only be able to afford a mortgage of £145,000, rather than £200,000.
The table above outlines how the amount that can be borrowed for a set monthly payment has changed dramatically due to higher rates.
With fixed rates at 2.5 per cent, a £1,500 monthly payment on a 25-year loan secured a £331,638 mortgage.
But with fixed rates at 5 per cent, that same £1,500 monthly payment gets a £253,691 loan.
You can check how big a mortgage a set monthly payment would get at different interest rates using our mortgage affordability calculator.
In reality, home buyers might have a bit financial wriggle room. They might be able to find extra money or borrow over longer terms.
Some may have increased their earnings since they last got a mortgage, allowing them to pay more each month; or built up enough equity in their home that they can remortgage on to a cheaper rate.
But other household bills have also gone up substantially and many will not be in that situation.
Unless those buyers are able rustle up a lot more money for monthly payments, or tens of thousands of pounds extra for a deposit, then the price of the house they can buy will have to give way.
Heading downwards: Mortgage rates spiked in Autumn 2022 following the economic chaos after the mini-Budget, but are now moving lower.
The mortgage squeeze
The mortgage market is triggering a property squeeze. House prices will continue on a downward trend in 2023, or at least that is what figures published so far this year seem to suggest.
House prices have been falling since the summer, according to the UK’s biggest mortgage lenders.
Nationwide reports that average prices have fallen 6 per cent since the August peak, while Halifax’s figures show a fall of 4 per cent since June.
This year, Nationwide and Zoopla are both predicting a further 5 per cent fall, while Halifax is predicting prices to drop 8 per cent.
While some blame can also be apportioned to rising living costs and the spectre of recession, housing market experts say the biggest contributing factor is higher mortgage rates – which have made it harder to both get approved for a loan, and make the monthly payments.
The average five-year fixed mortgage is currently 4.97 per cent, according to Moneyfacts. This time last year it was 2.71 per cent and the year before that it was 2.73 per cent.
This means that on average someone fixing for five years, repaying a £200,000 mortgage over a 25 year term will pay £1,166 a month today compared to £919 a month a year ago.
That’s an extra £247 each month, or £2,964 over the course of a year.
There has also been a stark decline in mortgage approvals for house purchases, suggesting that buyers are delaying decisions, or deciding not to move altogether.
The number of mortgages approved for house purchases is currently as low as it was in the aftermath of the global financial crash in 2009, according to new data from the Bank of England.
Approvals dropped 2.3 per cent in January to 39,600, down from 40,500 in December, the most recent figures show.
It was the fifth monthly fall in a row, as many homeowners see rises in their mortgage payments and household finances continue to be squeezed.
Check how much a mortgage would cost you based on loan size and property value with our best mortgage rates calculator.
House prices fell annually in February for the first time since June 2020, says Nationwide
What affordability checks are lenders doing?
At present lenders are restricted by mortgage affordability guidelines designed to prevent people from financially overstretching themselves.
These guidelines were supposedly relaxed last year when the Bank of England dropped its requirement for lenders to carry out affordability stress testing.
This had previously meant borrowers had to prove they could still afford their mortgage repayments if their mortgage rate was to increase to 3 per cent above their lender’s standard variable rate.
But even though it is no longer required, many lenders are still carrying out stress tests against hypothetical interest rate rises of different sizes, according to Chris Sykes, a mortgage consultant at broker Private Finance.
‘Most lenders do not advertise what they apply in their background stress tests.’ says Sykes. ‘However, I have heard from certain lenders that they aren’t necessarily applying the full 3 per cent as standard anymore. They can’t say what they are doing, but they have some flexibility.
‘Extra flexibility is also applied to certain cases such as longer-term fixed rates of five years or more, and sometimes first time buyers as they assume they are early in their careers and their income will rise.’
No stress: Last year, the Bank of England dropped its requirement for lenders to carry out affordability stress testing
Borrowing 4.5 times salary still the norm
The other element of affordability guidelines remains in place, however. The loan-to-income-ratio is a cap on the amount banks can lend based on annual salaries. This does not cap individual loans, some can go above this, but limits the amount of mortgages that can be written at high multiples.
This means banks continue to place a limit on the number of mortgages they can offer where someone is borrowing more than 4.5 times their salary.
However, some lenders have recently increased the maximum loan-to-income multiples that they can offer – albeit to only a small number of customers.
For example, this year, Mpowered and Clydesdale have both increased their maximum loan-to-income multiples to 5.5 times salary.
So could this help people to mitigate the effect of higher rates by allowing them to borrow more – and is that a good idea?
Affordability tests factor in customer outgoings and the cost of living crisis has of course bumped up energy, food, fuel and other commitments
David Hollingworth, L&C mortgages
David Hollingworth, associate director at broker L&C Mortgages, says that this higher level of borrowing is likely to be reserved for those that have more disposable income.
He says: ‘Many of the higher multiples will be for those that can meet minimum income requirements, as higher earners are more likely to have more disposable income to allow for a higher multiple, assuming they meet affordability.
‘Those with lower income levels and higher loan-to-values are likely to find tighter loan-to-income caps are in place.
‘The affordability tests will be factoring in customer outgoings and the cost of living crisis has of course bumped up energy, food, fuel and other commitments.
‘Lender affordability calculations will often factor in ONS data on costs and so that will be tightening the amounts for some borrowers.’
Chris Sykes of Private Finance says that while some can still afford to borrow the same amount as before the rate hikes, there are some who are finding it much harder now.
He cited a number of examples of clients who are no longer able to borrow what they could a year ago.
One was a single person with £55,000 annual income and a £7,500 bonus with minimal outgoings. Earlier last year he would have been able to borrow £275,000. However, now the same lender, will offer him only £235,000.
A second example, he says, is a couple with no children and minimal outgoings. One is earning £40,000 and the other is earning £45,000.
Their bank said it was was able to lend them £370,000 at the end of 2021, but it is now only offering £320,000.
What can buyers do if they can’t borrow enough?
Sykes says that, for many, the amount that they are able to borrow won’t have changed much compared to their income due to lenders downgrading affordability calculations.
But higher interest rates will obviously limit how far monthly payments will stretch borrowers.
‘We’ve seen examples of people now able to borrow tens or hundreds of thousands of pounds less than this time last year with the exact same lender, despite a person’s income and outgoings remaining unchanged,’ says Sykes.
‘Lenders haven’t become stricter in terms of income multiples, but it’s just harder to achieve those maximum income multiples because of stricter affordability rules.’
Higher mortgage rates and the cost of living is having ramifications for affordability and what people can borrow
Those on variable incomes, such as the self-employed and those getting bonuses, may need to consider looking at a self-employed specialist lender.
Sykes says: ‘Previously most lenders could still offer maximum borrowing on income multiples for clients with a variable income who were heavily dependent on commission, provided there were no further complications to the mortgage requirements and they had minimum committed expenditure.
‘Nowadays, we are finding more often than not, clients with large variable elements to their income are having to approach more specialist lenders to achieve the level of borrowing they want or a maximum figure.’
As well as looking at different lenders, he also says some borrowers struggling with affordability are deciding to borrow less in order to keep monthly payments they are comfortable with.
‘What I’m seeing now, is a lot more people deciding to not borrow the maximum they can possibly get,’ he says.
‘The monthly payments are now dictating what is too high for them rather than the lender’s affordability.’
Will rising wages make mortgages more affordable?
When considering what mortgage amount people typically can and can’t afford, it’s important not to ignore annual wage growth.
Regular pay, excluding bonuses, has grown at the fastest rate in more than 20 years, according to the latest ONS figures. Average wages were up 6.7 per cent in October to December 2022, compared to the year before.
However, after factoring in inflation – in real terms – growth in regular pay fell on the year in October to December 2022 by 2.5 per cent.
So while wage increases will mean that the average Briton is earning more than last year, the cost of living has risen by an even greater extent – and mortgage lenders will factor that into their calculations.
Chris Sykes says: ‘Wage growth definitely helps, but when you subtract the tax that an employee would pay on this additional amount and then factor in inflation being around 10 per cent in real terms, there is definitely reduced mortgage affordability.
‘The only examples I can think where someone could now afford more of a mortgage than last year is if they’ve had a big increase in income, they’ve managed to pay off a load of debts, or perhaps their business has rebounded from Covid.’
Find out how much you can afford to borrow for a monthly payment amount with This is Money’s mortgage affordability calculator.
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