Page last updated at 12:12 GMT, Friday, 27 April 2007 13:12 UK

How much money should you borrow?

Andrew Montlake
Partner, Cobalt Capital

When you apply for a mortgage or remortgage, many lenders will calculate the size of loan they offer you by multiplying your income by a set amount.

Andrew Montlake
These days you can borrow more, says Andrew Montlake

If you're applying for a mortgage on your own, for instance, they will usually lend around 3 to 3.5 times your gross annual income - hence the 'multiple' bit.

If, on the other hand, you're applying for a mortgage with someone else, they'll typically lend either 2.5 times your joint income, or 3 times the larger income plus 1 times the second income.

So, by way of example, if you earn 50,000 a year and your partner takes home 30,000 annually, and you're applying for a mortgage on a joint basis, many lenders will offer you in the region of either 200,000 (2.5 times 80,000) or 180,000 (3 times 50,000 + 30,000).

Basic earnings

It's worth pointing out that gross annual income is generally deemed to be your basic salary plus any guaranteed bonuses.

For many people, this is perfectly acceptable as they earn a basic salary only and have no bonuses or commission to take into account.

However some people earn a low basic salary but actually earn double or triple that amount via commission that is not guaranteed (let's say you're an estate agent, recruitment consultant, or work in advertising sales).

Income multiples clearly work against them, as lenders will often only look at the guaranteed chunk of their income.

Higher and higher

In recent years there has been a clear trend towards higher multiples, in some cases as much as 7.5 times annual salary (although 4 to 5 times salary is more common).

Lenders are currently offering larger multiples

This is mainly because interest rates, since the late nineties, have been consistently low and much less volatile.

In short, lenders feel the threat of borrowers being overstretched by sudden interest rate rises is significantly lower these days.

So they are happy to lend more than they would have done 10-15 years ago when interest rates were higher and the climate less stable.

Of course, low interest rates also mean mortgages are cheaper to repay, meaning there is less chance of borrowers defaulting, even on bigger loans.

The availability of longer fixed rate periods, from five to sometimes 25 years, is another reason why lenders are currently offering larger multiples, as there can be no ugly surprises for borrowers in the form of sharp increases in their repayments.

What sort of job?

In some cases, the type of employment you are in can also result in a bigger loan offer.

For example, if the lender feels the borrower has strong future earnings potential or will not struggle with the repayments because they are in very secure employment, they will tend to be more 'generous' with their multiples.

Doctors, accountants and solicitors fall into this category.

Lenders may also offer a higher multiple if the borrower puts down a bigger deposit, as they are seen as less of a risk.

However, consumer bodies stress that borrowers should always be extremely cautious when considering higher multiples because the repayments, relative to net monthly income, can be sizeable.

And if interest rates rise, the repayments will too if you've opted for a variable rate mortgage.

Thing of the past

Over the past few years, some of the big lenders have started to turn their backs on income multiples, which they see as crude and simplistic.

Income multiples will soon be a "thing of the past"

Instead, they are using a new criterion called 'affordability'.

This is considered to be a far more sophisticated and responsible approach to mortgage lending.

One high street lender even went so far recently as to announce that income multiples will soon be a "thing of the past".

Rather than apply a multiple to the applicant's gross annual salary, it sets out to determine the disposable income the applicant will have after all the other essential monthly spends and outgoings.

For example, as well as loan commitments, the lender will look at other areas of essential spending such as:

  • travel and transport costs.
  • food budgets.
  • council tax.
  • insurance premiums.
  • monthly credit card bills.
  • whether you have children living with you (with all the associated costs!).
  • the different types of household bills you are liable to pay.

With this knowledge, the lender gets a far clearer picture of what applicants can realistically afford to spend on repayments each month.

Overtime and bonuses

More positively, lenders may also take into account any regular overtime and commissions, even if not 'guaranteed' (a collective sigh of relief from all advertising sales executives).

What if someone has a gross annual salary of 30,000, but has, say, 5,000 in credit card debts, spends 250 a month on loan repayments and 100 a month on travel costs?

That person would be offered a smaller mortgage than an applicant with the same salary but no debts and travel costs.

In this sense, it's clear that people without debt will benefit most from the affordability-based approach, particularly if they are single with no dependants.

In many cases, they will be able to secure a mortgage far bigger than they would have using the income multiples system, allowing them to buy homes previously beyond their price range.

The opinions expressed are those of the author and are not held by the BBC unless specifically stated. The material is for general information only and does not constitute investment, tax, legal or other form of advice. You should not rely on this information to make (or refrain from making) any decisions. Always obtain independent, professional advice for your own particular situation.

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