Here we are at session number 62 , and we’re going to be talking about the new mortgage stress tests being applied to new mortgage applications. Things have got a whole lot tougher if you’re looking to get a mortgage. I’ll be looking at what has changed, and how best to navigate the new rules.

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Introduction

In the decade running up till 2006 or so, getting a mortgage was fairly easy. As long as you had the income to pay the loan, you were pretty much guaranteed to be offered one. You could even self-certify your income so you didn’t even have to provide payslips or self-employed accounts to justify a given loan amount. You didn’t even have to come up with a deposit in many cases. Lenders were throwing money around left, right and centre and it was all too easy.

Then the financial crash happened, and a massive part of the cause was mortgage debt going bad and coming back to bite the backsides of the lenders. Credit and the free flow of money seized up and banks stopped trusting each other – this became known as the credit crunch.

Now the finance industry regulator the Financial Conduct Authority has legislated to impose more responsibilities on lenders to ensure that any potential borrower can really afford to pay the mortgage. Unsurprisingly, this means that it is the lives of borrowers wanting to get on the housing ladder that have become more difficult.

As usual, I’ll over what you need to know about these changes first, and then what you need to do to navigate the new rules successfully.

Everything you need to KNOW

1 – Overview of the Mortgage Market Review (MMR)

I don’t know about you, but I always thought MMR was a controversial triple vaccine given to children, but it’s now a hot topic in the personal finance world as the Mortgage Market Review has come into force. As mentioned just now, it is the regulator’s attempt to crack down on the loose lending practices that got us into the deepest financial crisis the world has seen since the Great Depression of the 1930s.

There are two main things that the MMR is designed to ensure:

The first is affordability – we’ll deal with this more in a minute, but the days have now gone where you could borrow whatever you wanted thanks to easy lending models.

The second is suitability – there is a wide choice of mortgages available and getting the right one can be tough. Listen back to Session 18 for more info. The MMR is designed to make it essential to take advice. In fact, most mortgage lenders, unless they are branch-based like a bank or building society, won’t take your business unless you have seen a mortgage adviser or broker. Independent advice will come at a cost of course, making the process of getting a mortgage more expensive than it used to be for many people.

It is important to note that the MMR does not cover Buy To Let mortgages, but only those for residential house purchase or remortgage. A knock-on effect here is that if you already have a deal with a mortgage lender, let’s say a three-year fixed rate, and you are coming to the end of that deal, you will be approaching your existing lender to see what deals they can offer you, as well as looking to the wider market. It may be the case that your existing lender will not offer you a mortgage deal but instead will put you on their standard variable rate. They won’t withdraw your mortgage completely of course, but if their criteria have changed under the MMR it may be that there are no deals to be had.

Finally, the MMR introduces mortgage stress tests for ongoing affordability – let’s look at those now.

2 – Stress test 1 – Affordability now

The first stress test places a far greater emphasis on affordability now than ever used to be the case. Perhaps I shouldn’t say ‘ever’. Time was you had to meet with your bank manager and have your personal affairs combed through before you were offered a mortgage. Over time this was replaced by computer algorithms, leading to the famous ‘computer says no.’ But eventually, affordability became about a simple multiple of salary, less any other debt repayments. So a multiple of five or more times your salary was what you were offered. And in many cases you didn’t have to prove your income at all; you could self-certify it.

Under the MMR things are different. Firstly, income must be proven in all cases. To be fair, this has been the case since the credit crisis, but it is even more stringent now. You should be prepared to show 6 months’ payslips or three years’ accounts if you are self-employed.

Once your net income has been established, mortgage lenders are apparently asking all sorts of questions about your spending habits. These fall into a couple of main categories:

Essentials for living – Food, utilities like water and electricity, telephone, essential travel such as travel to work or school, council tax, buildings insurance, household cleaning and laundry.

After that come the quality of living costs – clothes, furniture and appliances, toiletries, basic leisure costs, TV licence and childcare.

Then there are repayments and other commitments for debt such as student loans, hire purchase and the like.

Each of these will be scrutinised and non-essential spending will likely be questioned. If you have a gambling habit, expect to be quizzed on this. Lots of Saturday nights out? They will ask about this. MMR is only a couple of weeks in force and already there are reports of three hour interviews with potential lenders and waiting lists developing at building society branches.

3 – Stress test 2 – Affordability if..

Under the MMR, lenders must not only satisfy themselves that you can afford the loan now, but also if mortgage interest rates rise. Fact is, rates have been this low for five years or more now, but we need to remember that these are the lowest bank base rates for 300 years. They will not stay this low, and when they rise, mortgage rates will rise with them.

And so the lenders are applying hypothetical rates to see if you can still afford the repayments if rates rise to, say, 7%.

But they will also consider and ask you about any likely changes to your income in future, including what might happen if you’re in a relationship and one day children come along. Will one partner work part time? What impact will that have on the income and is the mortgage still affordable then. I haven’t yet heard reports of this but it may be the case that if you plan to have kids in the future the lender will refuse you a mortgage.

They will also ask about any planned career changes, perhaps to retrain, which might entail a drop in income.

Are you getting the idea yet? It is much, much more difficult to get a mortgage now than it has been over the last 25 years. All a bit depressing really.

So we know now that the MMR has tightened things up and that it is not just affordability now that is being looked at, but affordability in the future. What can you do now to increase your chances of getting the mortgage you want?

Everything you need to DO 

1 – Know your spending

It’s always been a good idea, but now more than ever before it is essential to have a good handle on your spending. Regular listeners will know that I believe that it is possible to distil your financial health and future prospects down to one key tenet, which is to spend less than you earn. Only when you know your own spending habits can you make the adjustments necessary to win over a prospective lender.

If you don’t currently, I suggest you track all your spending for a month. Yes, that’s all your spending, down to the penny. Take a notebook out and about with you, or use a note on your iPhone to write down what you spend during  each day. Get into the habit: pay for something, write it down. Obviously things which are paid by direct debit or by swiping your bank card are easy to track, but cash is a killer for this. You take out £50 and before you know it, it has gone, with nothing much to show for the spending except some receipts.

Do this for a whole month. Yes, I’m serious. Yes, it is a pain, but it is a valuable exercise.

When you have a month’s spending written down, categorise your payments into logical groups like groceries, utilities, eating out etc.

When you have done this, look at where you can cut some fat. Are you eating out every weekend? Twice every weekend? Maybe you should cut this down if you’re going to convince a lender to put some money your way to get on to the housing ladder.

Look to save where you can, to give yourself the best chance of passing an affordability test. Be aware though that one month of changes isn’t going to convince a lender. You’ll need to show that you can live well within your means for a prolonged period of time.

2 – Deal with debt

One of the first things a lender will look at is existing debt. Do you have  credit card balances, an overdraft, a car loan, regular student loan repayments? You’ll need to work on cutting these drastically if a lender is to look twice at you for a mortgage.

Credit cards, overdrafts, car loans – these are bad debt and should be dealt with quickly. Listen back to Session 4 [LINK] for some steps to help you get out of debt, or watch video numbers 238 and 239 [LINKS].

Remember all these links are at the show notes: meaningfulmoney.tv/session62

I’m a huge advocate of Dave Ramsey’s Debt Snowball approach to clearing debt. Much more about that in the links above. You’ll need to get debt under control and prove you can live without it. Borrowing money for good reasons will be looked on favourably, as long as the repayment are affordability. Paying 30% on an Argos store account for an X-Box and a big TV is not going to win you any friends at the lenders’ underwriting department.

3 – Save for a deposit

Assuming your debt is under control, you’ll need to have saved a deposit. If you’re thinking of getting a mortgage, you may be at this stage already. Realistically, you’ll need a 10% deposit these days. You may be able to grey away with a 5% deposit, but it is unlikely.

If you haven’t saved a deposit yet you’ll need to be deliberate about this, putting money aside each month until you hit your goal. If you’re serious, you’ll need to make serious sacrifices. Live at home if you can and coerce your parents into charging you £10 a year room and board.

Seriously – the discipline needed to amass a decent house deposit these days should stand you in good stead with the mortgage lenders.

I would strongly urge you to deal with debt first. There’s not a lot of sense in saving up £100 per month and paying out £200 on debt repayments. Better to apply all £300 to the debt and clear it quicker, then you’ll have £300 per month to save.

The savings habit will show you have financial discipline, so start now, and give up what you need to give up to get this habit in place.

4 – Have the answers to hand

When you are being interviewed for a mortgage, you’ll need to show that you have control of your finances, so be prepared for the interview. Collate a list of your outgoings, and take along bank statements to back that up.

Show that you are aware of the responsibility of taking out a mortgage by treating this like a job interview – have the right answers to hand and you will look like you’re in control.

Unfortunately, these days so much power is taken out of the hands of the individual involved, that if the computer says no, you’re probably out of luck. But if there’s anything borderline about the underwriting of the mortgage, it will pay you to come across like you’re in control.

Summary

I think the whole MMR thing has swung the pendulum much too far. We certainly needed tighter lending criteria in light of the credit crunch, but the market had already achieved this for the most part. 100% and even 95% mortgages had all but disappeared and criteria were already tighter. I think that the only thing the MMR will achieve is a longer wait for most people to get on the ladder. Given that we largely define our sense of wealth in terms of our property price, this doesn’t bode well…

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Outro

That's it for this session of the MM podcast, I hope it was helpful. If I missed anything or if you have any questions, please leave them comments section below.

I hope you enjoyed this session. Thanks for listening – I'll talk to you next time.