Part 3: Mortgage affordability. How do you know how much you can afford?

Part 3: Mortgage affordability. How do you know how much you can afford?

Probably one of the most thought about question when it comes to buying a house is how do I know how much house I can afford? Typically mortgage providers will say 2.5x your total income (combined if there are 2 or more of you) but I believe this is the wrong approach and can be misleading. The reason for this is that you do not make your total income each year as you receive less than this paid into your bank account, monthly, over the year. So why would you decide how much house you can afford based of an income that you don’t actually receive?

The best target I have found is 33% of your NET income however I prefer to take 5% off of this for extra safety margins and includes all taxes, utilities and insurance. Now net income is different to total income as net income is minus all taxes, student loan repayments, pension contributions and many other schemes that get taken out before your salary is paid to your bank account. Essentially your NET income is your take away pay and is the money that is remaining on your pay slip that you receive each month. Below is a spreadsheet that I used when deciding on what property I could afford with my partner. I have put some representative numbers in just to make this easier to see how it would look.

So let’s take a look and you can find the spreadsheet link at the bottom of this page…

Mortgage affordability

I have this broken down in different sections. So the left is the mortgages calculations along with deposit calculations to determine how much is left to save. The next column to the right determines the Net income affordability with the utilities and mortgage combined to be a percentage of the income. The next 2 tables are for each person on the mortgage (assuming there are 2). This allows each person to see how much of their income is left after the mortgage and fixed bills which can be taken from part 1.

The bottom right is an additional factor that most people forget about when saving for a house deposit. That is the cost to get a mortgage itself. This comes from Part 2 released earlier and will vary depending on your location but this gets added to the left to save cell.

Mortgage calculations

The table above has yellow shaded cells which are values that you need to enter. These are quite easy to understand however there is some work needed for some of them to get the right numbers. House price is just the value of the property you are looking at. The next 2 yellow cells are related to the mortgage and in this case you would need to request some quotes to get an idea of how much this would be. This can be done through a solicitor or a mortgage comparison site would be good enough for the early stages of looking for a property. This would give you a typical interest rate at that time and the life of loan is just the duration you wish to pay for. There was more information on this in part 2 mortgage glossary which I posted earlier on. I have put the down payment as 10% from the last post however you can edit this to be whatever you feel is necessary.

Taxes and insurance are also more complicated and require some research on your side. Taxes for most UK properties means council tax which varies depending on which area you are looking to buy a property in. Fortunately, it is normally easy to find as most house searching sites will detail this amount for you otherwise you can search on your local council site and use the property post code to get an accurate value. Insurance here just counts as buildings insurance. This is required by law on your property and typically £150 is a good enough estimate on the cost of this.

I determine utilities to be your gas, electric and Wifi costs each month.

The total of the mortgage payment each month, annual taxes and annual insurance is your total mortgage payment. Now in addition to this I like to include utilities on top so that the majority of the costs of owning your own house is covered. You can make this accurate to yourself by using your current budget and costs for utilities and adjust the additional value but for this example I have left it at £200 a month assuming 2 adults.

The sum of payments and the interest cost is one cell I would like to mention which is not shaded yellow. This shows the amount of interest on the loan and leads well onto the next post which will be Part 4: mortgage amortisation calculator. This will show you how overpayments can give you a guaranteed return on your loan.

The help to buy ISA value is only relevant if you have one running already as these no longer exist. However, a lifetime ISA is an option and gives you the same benefit when buying your first home. The only main difference is that within a lifetime ISA you can no longer move money as freely without incurring a penalty ie once you put money into this account you cannot transfer it to another account whenever you like, without paying a fee.

For the last 2 yellow cells you can enter the amount of savings you have per person for the mortgage. This will then allow the green cell to tell you how much you have left to save in order to buy a property of your specified cost.

Mortgage affordability

The next section is the main value from this spreadsheet. The first 2 yellow cells here are for the total salary for each person while the 3rd cell is for any additional income that comes in. For simplicity I take the value of combined total income however, if you are buying a property on your own then you can just make one of these £0 to make it easier. To determine the net income I minus 31% of the total combined salary which for me is around the right number when I remove income tax, student loan repayments and pension contributions for both of us. The green cell here then determines how much of this net income each month is taken up by the utilities and mortgage costs from the left side table mentioned previously. As you can see here this value is 29.55% meaning that 29.55% of your combined net monthly income would go towards paying utilities, mortgage repayment, taxes and insurance. In this case it would be above the 28% recommended but less than the 33% actual. This would be a risk tolerance measure for you to decide. For people in riskier work or with kids you might want to go even lower than 28% however for a younger person with a solid career going to 33% may be viable as your other living costs may be less.

The cells beneath this determine how much would each person have remaining each month once all the house costs have been paid for. This leads to the next tables.

Personal budget costs

I like to add these tables in as it can give you an idea of your risk tolerance for your monthly costs. Taking some of the values from the budgeting spreadsheet I shared in part 1 you can add these values into this spreadsheet. These columns will give each person an idea of how much they would have left once house costs and fixed bill costs have been taken out. This is very helpful for budget planning and also gives you something to evaluate against. For example, you may decide that the house you are looking at is actually much closer to work for person 2 and you no longer need a car per person and you would just share the 1 vehicle. The same would apply for things like childcare if you are moving closer to family who are happy to look after children. This way you can split your monthly costs and really evaluate benefits of a property. For example, if the house costs 38% of your net income but you save 10% elsewhere consistently then this would be functional.

Mortgage fees

This is often forgotten about when saving for a property, as most only thing of the house deposit, but is important to understand before you put in offers. This takes some of the terms and fees from Part 2 which you should read for more detail. The cost here will be varying depending on your approach. Mortgage advisors, extensive surveys and solicitor choices will all have different costs. The total value here is added to the amount left to save cell in the first table explained above so you know there won’t be unexpected costs. There are further cells here to add any other costs you may need to consider.

I hope this has helped you in some way understand where you are at and to make the best financial decision for yourself and your family. Feel free to share the spreadsheet but if you could like and share this post it would really be appreciated and there is a donate option should you like to leave one.

https://docs.google.com/spreadsheets/d/1Q-9vZ5WoJ1JLnqc6Jmia6-ePE26IPTua_4ZHYJXiiBw/edit#gid=535021146

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