Income Multiples

[cock-eyed octopus]

... the logic behind income multiples?

I keep seeing some value for this (usually 3.5*income) quoted as being holy writ so far as mortgage affordability is concerned.

I just can't see this.

Whether you're earning 10k or 100k, your fixed costs are going to be essentially the same. The richer person may choose (almost certainly) to spend more on non-essentials, but they don't HAVE to. The balance can surely be used to spend on a mortgage, if they wish.

The effect of tax allowances, banding etc. will diminish the differential, but I would maintain that someone on 100k p.a. is much more able to afford a 500k mortgage than someone on 10k p.a. is able to afford a 35k one.

Perhaps someone could provide some comparative figures for me. (Or has this already been done?)

[200p]

I dont have the figures, but 3.5 is the way to go.

I dont think fixed costs would be the same. A 500K house would be proportionately more expensive to keep - e.g. energy bills, repairs, etc - theres just more to do! And if you are in a Grade II listed building, you have to use special materials in keeping with the building for any repairs - E.g. thatched roofs.

They will also have to have a better car to go with the house inevitably + the extra costs of running a nice car.

3.5 is the magic figure that my parents were advised to go on by the halifax when they bought their house all those years ago.

Sensible advice!

Seems its gone out of the window now, and lenders are prepared to lend out more.

.

[Once in a lifetime]

Self-cert mortgages could skew market

Wednesday, 11 February, 2004

http://news.bbc.co.uk/1/hi/business/3478635.stm

For decades, the maximum a borrower could raise on a mortgage had been set as a multiple of income.

On a typical multiple of three-and-a-half times income, the most someone earning £30,000 would be able raise on a mortgage was £105,000 - that is 3.5 x £30,000.

The income multiple rule was rough and ready, but it was effective in stopping borrowers from borrowing more than they could afford and lenders from lending more than was prudent. 

With these new so-called "self-certification" mortgages, borrowers simply stated their income and lenders made it clear they would not check the amount borrowers claimed.

Sometime in 2004 the FSA gave guidelines to the Council of Mortgage Lenders

Tightening the rules of self-cert mortgages (I can't find a link?)

It was passed by Parliament and soon after mortgage approvals dropped like stones

(I think it was around Feb or March 2004)

I hope zzg or someone that can post a link to it. It has to be the turning point in the boom

[zzg113]

Sometime in 2004 the FSA gave guidelines to the Council of Mortgage Lenders

Tightening the rules of self-cert mortgages (I can't find a link?)

It was passed by Parliament and soon after mortgage approvals dropped like stones

I don't think mortgage regulation caused the huge drop we have seen in mortgage approvals. It was passing the peak of a bubble that did it (recall Professor Pepper's analysis):

http://www.telegraph.co.uk/property/main.j.../17/prosy17.xml

Income mulitples are there to protect the lender, no other reason. They are not in the business of making loans that people will default on.

[cock-eyed octopus]

I dont have the figures, but 3.5 is the way to go.

I dont think fixed costs would be the same. A 500K house would be proportionately more expensive to keep - e.g. energy bills, repairs, etc - theres just more to do! And if you are in a Grade II listed building, you have to use special materials in keeping with the building for any repairs - E.g. thatched roofs.

They will also have to have a better car to go with the house inevitably + the extra costs of running a nice car.

3.5 is the magic figure that my parents were advised to go on by the halifax when they bought their house all those years ago.

Sensible advice!

Seems its gone out of the window now, and lenders are prepared to lend out more.

.

<{POST_SNAPBACK}>

Sorry, still can't see what's magical about 3.5, or any other multiple.

Looked up some figures:

£500k mortgage over 25 yrs. = £2956 p.m. Income £100k p.a. = £5340 p. m.

so residue > £2300 p.m.

£35k mortgage over 25 yrs. = £207 p.m. Income £10k p.a. = £708 p. m.

so residue = £501 p.m

Who's at greater risk?

[zzg113]

3.5 is the average long-run price-to-earnings ratio for UK house prices established over the last 60 years since WWII, and hence is seen by many on this site (myself included) as the sustainable trend P/E ratio.

[Once in a lifetime]

I  don't think mortgage regulation caused the huge drop we have seen in Income mulitples are there to protect the lender, no other reason. They are not in the business of making loans that people will default on.

<{POST_SNAPBACK}>

If everything goes wrong for the borrower and they can no longer meet the payments on a fraudulently obtained outsize mortgage, the lender is unlikely to lose money.

Even if a borrower defaults, a lender can repossess their home and sell it to recover their money.

Surly zzg it must have made some contribution???????

[the don]

lets look at mortgage multiples for man wiith non working wife and 2 kids

assume he earns £40000p.a-above average salary

tax and ni amount to nearly £9000, leaving him with £31,000p.a or £2600 per month take home

if he borrows 3.5 x salary - £135000.

at 7% repayment mortgage he will pay £1000 per month in mortage.

add council tax gas, electric imnnsurance etc together -say £300/ month.

he is left with £1300 to cover food transport clothing etc.

if interst rates go to 8. 5% his repayment mortgage is £1130 per month and he has £1170 left for everrything else.

if he borrows 5X salary-£200,000.

at 7% repayment mortgage he pays£1430/ month leaving him with £870 for food etc

at 8.5% repayemnt he pays £1630/ month leaving £670 to feed an clothe family.

if mortage interet rates hit 8. 5% there is a good chance that he will at some point be unemployed. he may need to take a pay cut to say £35000 to get a job.

result: he will barely be able to feed his family.

if property prices drop he will get the double whammy.

the lender however, will not lose.

what is teh chance of mortgage interest rates hitting 8.5% ?

pretty high with UK and US borrowing out of control.

[cock-eyed octopus]

3.5 is the average long-run price-to-earnings ratio for UK house prices established over the last 60 years since WWII, and hence is seen by many on this site (myself included) as the sustainable trend P/E ratio.

<{POST_SNAPBACK}>

It was also seen that the Earth was flat & the centre of the Universe & house prices always went up.

I'd be grateful for the rationale, please.

[200p]

Sorry, still can't see what's magical about 3.5, or any other multiple.

Looked up some figures:

£500k mortgage over 25 yrs. = £2956 p.m.   Income £100k p.a. = £5340 p. m.

so residue > £2300 p.m.

£35k mortgage over 25 yrs. = £207 p.m.   Income £10k p.a. = £708 p. m.

so residue = £501 p.m

Who's at greater risk?

<{POST_SNAPBACK}>

Of course the person on 100K is at less at risk - but thats not the average person.

For arguements sake - the least you borrow the better. If you can save 100% for a house and buy without borrowing that would be excellent but not practical.

I think Charlie the tramp once said if you borrow 5K you pay back 10K. Wise words!

Like ZZG said, 3.5 or below is sustainable (thanks zzg). Today we are seeing people borrowing 5x their incomes and more. This is not sustainable at all because when interest rates rise, wages are not going to rise instep to meet mortage repayments.

[cock-eyed octopus]

lets look at mortgage multiples for  man wiith non working wife and 2 kids

assume he earns £40000p.a-above average salary

tax and ni amount to nearly £9000, leaving him with £31,000p.a or £2600 per month take home

if he borrows 3.5 x salary - £135000.

at 7% repayment mortgage he will pay £1000 per month in mortage.

add council tax  gas, electric imnnsurance etc together -say £300/ month.

he is left with £1300 to cover food transport clothing etc.

if interst rates go to 8. 5% his repayment mortgage is £1130 per month and he has £1170 left for everrything else.

if he borrows 5X salary-£200,000.

at 7% repayment mortgage he pays£1430/ month leaving him with £870 for food etc

at 8.5% repayemnt he pays £1630/ month leaving £670 to feed an clothe family.

if mortage interet rates hit 8. 5% there is a good chance that he will at some point be unemployed. he may need to take a pay cut to say £35000 to get a job.

result: he will barely be able to feed his family.

if property prices drop he will get the double whammy.

the lender however, will not lose.

what is teh chance of mortgage interest rates hitting 8.5% ?

pretty high with UK and US borrowing out of control.

<{POST_SNAPBACK}>

And the guy on £10k??

[cock-eyed octopus]

Of course the person on 100K is at less at risk - but thats not the average person.

For arguements sake - the least you borrow the better. If you can save 100% for a house and buy without borrowing that would be excellent but not practical.

I think Charlie the tramp once said if you borrow 5K you pay back 10K. Wise words!

Like ZZG said, 3.5 or below is sustainable (thanks zzg). Today we are seeing people borrowing 5x their incomes and more. This is not sustainable at all because when interest rates rise, wages are not going to rise instep to meet mortage repayments.

<{POST_SNAPBACK}>

There is no logic to this at all. The person on £10k is in a far worse position whatever happens. Unless someone gives me a RATIONAL explanation for income multiples I can only conclude there isn't one.

[the don]

the guy on £10k in todays market will only be able to rent-either privately or through social housing for as long as these ludicrous property values persist.

this is a life of slavery with no incentive to improve his lot in life.

not many years ago you could buy flats and victorian terraces in many parts of the country for £40000.

very few properties of that sort are about at those prices, and even fewer in places where there is a god economy with work.

as i dont believe incomes will race away, HPC or social unrest are the only 2 possible outcomes

[thunderbird900]

Mortgage regulation was brought in 1st November 2004. This effectively stopped self cert being abused. Nowadays, any mortgage adviser going down the self cert route for an employed person has to have a very good reason for doing so. The 3.5 income multiple is a long standing set standard that is used to gauge affordability for any buyer. This protects both the buyer and lender.

Lenders do not want to be left with loads of properties on their books if the borrower defaults. They are there to lend money, not become estate agents when house prices go down. Besides, a lot of lenders impose a mortgage guarantee premium on borrowings over 85%. This insurance protects the lender, NOT the borrower, as lots of people with negative equity found out in the last crash.

[cock-eyed octopus]

Mortgage regulation was brought in 1st November 2004. This effectively stopped self cert being abused. Nowadays, any mortgage adviser going down the self cert route for an employed person has to have a very good reason for doing so. The 3.5 income multiple is a long standing set standard that is used to gauge affordability for any buyer. This protects both the buyer and lender.

Lenders do not want to be left with loads of properties on their books if the borrower defaults. They are there to lend money, not become estate agents when house prices go down. Besides, a lot of lenders impose a mortgage guarantee premium on borrowings over 85%. This insurance protects the lender, NOT the borrower, as lots of people with negative equity found out in the last crash.

<{POST_SNAPBACK}>

This has nothing to do with the logic, or otherwise, behind income multiples.

[Once in a lifetime]

Mortgage regulation was brought in 1st November 2004. This effectively stopped self cert being abused.

<{POST_SNAPBACK}>

I stand corrected then, It blows my theory out the window

do you have a link?

[200p]

There is no logic to this at all. The person on £10k is in a far worse position whatever happens. Unless someone gives me a RATIONAL explanation for income multiples I can only conclude there isn't one.

<{POST_SNAPBACK}>

I was agreeing with you that the person on 10K is in a worse off position.

The rational explanation for income multiples as I see it - you should only spend a roughly a third of your income on living costs whether that be renting or paying back a mortgage. You should therefore have some money left over either for savings or money for a rainy day e.g the roof needs repairing or the car breaks down. This is what my elders tell me - though people dont listen to their wise words these days - and youd be a fool not to.

If people are are borrowing more, meaning higher monthly repayments that doenst give them much room for error and thus you are living on the margins. Coupled with the fact a lot of people are living beyond their means, i.e. spending more than they are earning. We are in for trouble.

If you still dont see the point of income multiples, I ask somebody to explain this better.

1.1 trillion of debt - wake up and smell the coffee Britain!

[zzg113]

If everything goes wrong for the borrower and they can no longer meet the payments on a fraudulently obtained outsize mortgage, the lender is unlikely to lose money.

Where is this quote from BB? If a borrower defaults on a loan the lender loses money because the mortgage payments are no longer coming in and they have to incur time and expense to repossess and sell the property, and it may not fetch enough to clear the loan secured on it.

Even if a borrower defaults, a lender can repossess their home and sell it to recover their money.

This did not protect lenders in the last crash.

Unless someone gives me a RATIONAL explanation for income multiples I can only conclude there isn't one.

I've already given you one: they are there to protect the lender's investment. The crucial factor in whether a lender makes a loan to you is how affordable the LENDER considers the loan to be for you over the life of the loan, not how affordable you consider the repayments to be.

[the don]

i hate to dsiapoint you but my son who earns c £17k p.a. has been told he can borrow 5X his salry.

he has no deposit and a cr*p credit history

the banks are akin to the drug dealers who exploit the weak and uninformed

look at the salaries of people like fred goodwin, chief honcho of RBS

his bank is as guilty of exploiting the poor as any inner city drug baron, but he cant be jailed for it-yet

[cock-eyed octopus]

I was agreeing with you that the person on 10K is in a worse off position.

The rational explanation for income multiples as I see it - you should only spend a roughly a third of your income on living costs whether that be renting or paying back a mortgage. You should therefore have some money left over either for savings or money for a rainy day e.g the roof needs repairing or the car breaks down. This is what my elders tell me - though people dont listen to their wise words these days - and youd be a fool not to.

If people are are borrowing more, meaning higher monthly repayments that doenst give them much room for error and thus you are living on the margins. Coupled with the fact a lot of people are living beyond their means, i.e. spending more than they are earning. We are in for trouble.

If you still dont see the point of income multiples, I ask somebody to explain this better.

1.1 trillion of debt - wake up and smell the coffee Britain!

<{POST_SNAPBACK}>

For Gawd's sake.

If the person on £100k is in trouble on WHATEVER income multiple, then the person on £50k is in worse trouble (on that multiple) & the poor bugger on £10k has just jumped off a bridge.

You are completely missing the point  & introducing spurious moral arguements as well as appealing to authority rather than rationality.

AAARRGHH!!!!

[cock-eyed octopus]

I've already given you one: they are there to protect the lender's investment. The crucial factor in whether a lender makes a loan to you is how affordable the LENDER considers the loan to be for you over the life of the loan, not how affordable you consider the repayments to be.

<{POST_SNAPBACK}>

This is NOT a rational explanation. It is an appeal to authority (the lender). A rational explanation would involve some financial calculation.

[Once in a lifetime]

Where is this quote from BB? If a borrower defaults on a loan the lender loses money because the mortgage payments are no longer coming in and they have to incur time and expense to repossess and sell the property, and it may not fetch enough to clear the loan secured on it.

<{POST_SNAPBACK}>

The quote zzg was from the link in my post "http://news.bbc.co.uk/1/hi/business/3478635.stm"

Wednesday, 11 February, 2004

And ‘they’ will (as you know!) pursue you for the balance after selling your

Reprocessed home

This did not protect lenders in the last crash.

Agreed, did not protect lenders in the last crash but even less to the borrowers!

What do you think would happen if ‘they’ turned a blind eye to self-cert again???

[Cassandra]

I seem to remember that when we first bought in 1982 the maximum mortgage was 2.5x salary#1 + 1.0xsalary#2. Can't remember the interest rate but probably around 7-8%. However we had Miras which provided tax relief on I think the 1st 30k. Since our mortgage was 32k then only the top 2000 pounds was at the full rate. With income tax at (again I think!!) about 27% this reduced our mortgage payments by almost 100 pounds a month. Even still it was a stretch to cover our bills the first couple of years. For instance our car packed in so we did without, relying on friends for lifts and public transport. For holidays we found a cheap car hire place that would let us have a Ford Escort for 100 quid a week.

Comparing our experience in the 80's with now:

1). No more Miras. OK this didn't reduce the mortgage dramatically but until the late 80's most mortgages were below the limit and it reduced the effective interest rate a couple of percent. This is often forgotten in comparing costs now with those 20+ years ago. 9I have not seen this point raised previousy in this forum. It isn't a major effect but should be included in comparing historic trends.)

2). Higher inflation really helped. Although interest rates were higher salaries also increased dramatically so that within 3 years the mortgage wasn't so bad. In the present situation most folks are lucky to get an extra 2% per year. Relative poverty can be managed for a year or two but after that it can get very tiresome (to say the least)!! This time round lower (wage) inflation means that anyone buying now will be stuck with their mistake for 10 years or more.

3). Both then and now there were people that were able to borrow more than was good for them. These were usually the folks that came unstuck first. Just because you can get a loan it doesn't mean that it is sensible to take it.

4). What I heard in 1982 when we first bought was that previously (not sure when but probably mid 70's) wifes income could be included for the first time (the 1.0x salary). This of course meant that within about a year house prices had increased by this amount.

I don't think 3.5x is universal and I would be wary about borrowing the maximum possible. If that means renting another year or two then so be it. If you are a potential FTB please wait!!! Don't borrow more than you can really afford. What if interest rates go up 2%??. What if you lose you job?? What if house prices crash??

Don't be influenced by fools!!!

[Once in a lifetime]

i hate to dsiapoint you but my son who earns c £17k p.a. has been told he can borrow 5X his salry.

he has no deposit and a cr*p credit history 

the banks are akin to the drug dealers who exploit the weak and uninformed

look at the salaries of people like fred goodwin, chief honcho of RBS

his bank is as guilty of exploiting the poor as any inner city drug baron, but he cant be jailed for it-yet

<{POST_SNAPBACK}>

That is worrying, are you trying to talk him out of it?

I thought you needed at least a 10% deposit for self-cert??

[zzg113]

A rational explanation would involve some financial calculation.

How can you calculate the probability that someone will default? Considering that the future path of interest rates over 25/30 years, the person's job security, their marital status, their spending habits, and a thousand and one other factors that affect a person's ability to service a loan are changeable at a moment's notice and inherently uncertain, the lender is better safe than sorry by lending according to a criterion which has stood the test of time as the barometer of prudent lending.