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27 Jun 2022

Making Cents: Mortgage application stress tests

Making Cents: Mortgage application stress tests

The Home Ownership Rate in Ireland averaged 73.17 percent from 2003 until 2020, reaching an all time high of 81.80 percent in 2004

IF YOU'RE applying for a mortgage, the amount a bank will lend to you is 3.5 times your gross annual income, or your combined gross annual income if you’re buying with a partner, friend, or sibling.
The 3.5 times multiple is a quick and easy and familiar calculation for most would be buyers, but don’t assume that that’s it, and that’s the amount you’re guaranteed to secure, because it isn’t.
Lenders will carry out two tests to ensure the 3.5 times rule stands up, and the first is finding out whether you have demonstrated an ability past and present to repay the amount you are looking to borrow.
The second test they’ll carry out is, to see what funds are left over after your mortgage and any other loans you may have, are accounted for. They will want to see a minimum amount left over, that they deem is enough for you to be able to live off.
And this last test is really important, especially for those who have other loan commitments and I’ll explain why in a moment and tell you about a couple who were impacted by this.
Before I do, let me tell you about the first test you have to pass, and that’s showing you have an ability to repay this new mortgage amount you’re looking for.
Banks refer to this as your repayment capacity and they want to make sure that any new mortgage you’re taking on won’t be a shock to your system. And how they’ll get a comfort from knowing that it won’t, is where you can prove to them that over the past 6 or 12 months, through regular monthly savings, rent payments or a combination of both, that the sum total of both or just one, is greater than or equal to what your new mortgage repayment will be.
So, if you’re taking on a new mortgage and the monthly repayment is going to be for example €1,400 per month, they want to see that you have been saving this amount each month or paying this amount in rent each month or as I said a combination of both.
You could be earning a high salary and have an ability to borrow much more than the 3.5 times income multiple, but if you’re not showing a bank that you can meet that new mortgage repayment through savings or rent repayments, you’re not going to get a formal approval until you do.
One client of mine didn’t have any trouble showing a bank she had a capacity to repay the monthly repayment of the new mortgage she was proposing to take on. She was saving €1,300 per month and her new mortgage was going to cost exactly that, but after a quick call, I suggested that she increase her monthly savings to €1,600, which she was capable of doing, and there were four reasons behind my suggestion.
The first was that, when banks are applying their various stress tests, you don’t want to be on the limit of what’s acceptable to them. You’re still likely to be approved if you are but receiving that application where their looking for €1,300 and they see €1,600, will give them huge comfort, and will accelerate the approval process because this is the type of borrower banks will want to lend to.
The second reason was for her to get used to what her mortgage/property related costs are going to be. It’s not just going to be the mortgage repayment. She’ll have life assurance and home insurance costs, property tax, property maintenance etc. and saving that excess of what just her mortgage repayment will be, will help when she does encounter them because encounter them, she will.
The third reason is she’ll just add to her savings before she ends up completing a purchase.
If she doesn’t identify a property or is unlucky with the purchase of one for say a year, well then that’s an extra €3,600 she’ll have added to her savings which will pay towards her legal costs, home furnishings or whatever she wants it to.
My fourth reason is that she may need to borrow more than the 3.5 income multiple.
If this happened and she needed the bank to increase the multiple, no better way by showing that she could because of her monthly savings rate.
Okay, the next test a bank will look at, is by looking at what amount is left over after you’ve made the monthly mortgage repayment, and this is where existing loan commitments can impact an application.
You may have ticked the box on the income multiple, and you’ve ticked the box on showing repayment capacity, the next box you need to tick is the amount left over from your monthly income, after your mortgage repayment and any other loans you may have, are paid.
For a single applicant they’ll want to see about €1,400 left in their account and for a couple it’s c. €2,100. These amounts can vary from lender to lender so worth finding out what amount each are looking for.
When a bank is doing this calculation, they’ll stress your mortgage repayment by adding 2% to their variable rate and working out what that monthly cost is.
However, you can avoid this high stress rate somewhat if you choose a fixed rate for five years or more.
The Central Bank who insist banks carry out these stress tests, allow banks to stress test at prevailing fixed rates as long as the fixed rate duration is greater, as I said than five years.
Which makes it easier to pass this third test, because rather than subtracting a mortgage based on a rate of 5%, they are basing it on one that could be in the low 2’s.
I met a couple recently who are in the process of actively looking for a property. They’re both in permanent employment, good savings, good family support etc. so they look to be well set up.
He thought a bank would just look at the 3.5 times income multiple and that’s the amount they would qualify for, and to be fair to him, you don’t know what you don’t know, right? So, he wasn’t to know how much of an impact taking on a new car loan with a monthly repayment of €550 was going to have on how much they would be approved for.
And the impact, was an approval which was €45,000 lower than if he didn’t have the car loan, or at least didn’t have as high a monthly repayment.
So, other loans can matter hugely depending on their monthly cost, depending on your monthly income, and depending on what’s left over after everything is accounted for. So, be cognizant of them and know before you do anything what impact they may or may not have if you plan on making a mortgage application in the short to medium term.
Whenever you submit an application for mortgage approval, my advice is to be prepared, and familiarise yourself with the various stress tests a bank will carry out. You’ve got to carry out your due diligence as much as a bank would do on you when they receive your application and familiarising yourself by asking these types of questions of a bank or broker when you have that initial meeting with them is really important.
Liam Croke is MD of Harmonics Financial Ltd, based in Plassey. He can be contacted at liam@harmonics.ie or www.harmonics.ie

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