Understanding borrowing limits and affordability

13 December 2022
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When reviewing a mortgage application, we look at the application from a range of different angles.

The application must satisfy several rules, including:

Fundamentals

  • Applicants are EU Citizens or have stamp 4 visas or a stamp 1 critical skills visa.
  • Finances are very well managed with consistent savings and spending habits are prudent. If renting, rents are paid on time by bank transfer.
  • Personal loans and credit cards are kept to a minimum and repayments are always up to date. It is preferable to have zero short term debt when taking on a mortgage.
  • Employment is secure, income is consistent and well established. Employment prospects for the future are good. 

Once the applicants profile broadly matches the criteria above and they can prove affordability, it is likely that they will be approved for a mortgage.

 

Sample case.

We will take the example of a young married couple with a two-year-old baby 

Assume applicants are European Union citizens.

  • Their incomes are €40,000 and €32,000 and they are buying their first home.
  • They have one car loan costing €280 per month and actual childcare costs of €500 per month.

 

Test 1

Central Bank rules

First time buyers can borrow up to 4 times gross income and up to 90% of the purchase price.

Second time buyers can borrow up to 3.5 times gross income and up to 90% of the purchase price.

Limited exceptions are allowed to these rules for a small number of cases.

For our couple their maximum mortgage under new Central Bank guidelines will be calculated at 4 times their annual gross income - €72,000 * 4 = €288,000.

The monthly cost of a typical 5-year fixed rate mortgage over a 30-year term at 3.55% is €1,265 per month. If rates rise were 5.5% the cost would be €1,589 per month.

We always stress test applications to see what the mortgage would cost if rates were 2% higher than they are today.

Based on a maximum mortgage of €280,000, the couple could consider buying a house up to the value €320,000.

They will need a house deposit of €32,000 (10%) and additional funds for stamp duty €3,200 (1%) and professional and legal fees estimated at €3,000. In total €38,200.

(Help to buy assistance for first time buyers may be available for newly constructed homes)

 

Test 2 Affordability

The next calculation reviews whether, in principle, the mortgage is affordable.

Lenders have general rules to calculate how much mortgage holders should have available to live on after they have met their mortgage and other financial commitments.

For example, a single person should have €1,400 per month available.

Couple would need €2,200.

If the applicants have dependent children, add a further €300 per child.

Our couple should therefore have €2,500 left over to cover living expenses.

We have calculated take home pay for our couple at €5,007 per month.

Car repayments €280 and childcare costs €500 cost €780 per month.

Based on this scenario the funds available to cover a mortgage are calculated as follows:

To summarise

Take home pay €5007,

Less

  • Stress test mortgage monthly cost €1589
  • Car loan €280
  • Childcare costs €500
  • Minimum amount required for living expenses €2,500

Total out goings €4,869

Cushion €138

 

Test 3 Evidence of affordability

Perhaps the most important test is examining the real evidence of affordability.

The test involves a detailed examination of their bank accounts over the past six months to confirm that the couple have demonstrated that they could pay €1,589 per month on a mortgage.

To prove this, the account balances must have grown by this figure consistently each month or they may have paid rent at this level or a combination of rent and savings which is also evidence of affordability.

Finally, it is helpful to consider what percentage of your normal net income is taken up by you mortgage commitments.

 

Test 4 high level view on mortgage commitment 

As a guide Mortgages should not account for more than 35% of your net income

In the above example the stress mortgage monthly repayment as a percentage of net monthly income is 32%. This level is considered satisfactory.

Commentary

  • The figures show that the cushion between the stress tested mortgage and the funds available to meet the repayments is only €138 per month - This is very tight and leaves little room for unpredictable expenses that happen in every household.
  • The car loan at €280 per month is a significant monthly outgoing.
  • Should the couple consider borrowing less?
  • It would be very helpful before deciding on a borrowing amount that the couple do a detailed budget.
  • We are in an era of rising interest rates. Some attractive long-term rates are still available, and our general recommendation would be to fix long term.