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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Part 2: Mortgages glossary and tips

Mortgages are typically the biggest financial decision that people will make in their lifetime. One of the most common situations is when people will determine what they can afford to spend each month, pick a very expensive house and then pay for that house over the longest duration they can in order to achieve that monthly payment and get the lowest interest rate possible. This is not often the best way to go and can often leave you stuck in your job and “house poor” where you no longer have savings each month just to repay your mortgage.

This will go through some features of a standard mortgage for a home and tips afterwards and next chapter will go through mortgage types and an affordability calculator.

Check out Part 1 if you haven’t already where I discuss budgeting and share a budget template you can use for yourself.

Features of a mortgage

Feature	Description
Down payment / Deposit	Your down payment, or deposit, is the amount you put up front to secure the mortgage loan from a bank or building society. The lowest amount for a standard mortgage in the UK would be a 5% down payment meaning 5% of the property value for example a £200,000 home would have a 5% deposit of £10,000 (200,000*5% or 200,000*0.05). A 0% down payment is only available under a guarantor mortgage in the UK which relies on someone becoming liable for you should you fail to pay your monthly payments.
Principle	The principle is the amount you borrow from the bank or building society. Using a £200,000 home with the 5% down payment again would mean the principle would be £190,000. This £190,000 is what you borrow from the bank and this will vary depending on the property value and your down payment.
Interest	Of course banks do not lend for free (as nice as that would be). The interest is the additional charge that the bank adds to your principle amount and is calculated monthly. However, the value that will be on your mortgage will be a yearly value. For example, a 3% interest rate would be a 0.25% monthly rate (3/12 months in a year). In the £200,000 example this would mean you pay £500 in the first month in interest. You may think this would mean you pay less each month after the first as if you pay £1000 in the first month on a £200,000 house with 5% down payment then you only owe £189,500 (£190,000 principle minus £500 due to the other £500 paying the interest). Surely next month you should only pay 0.25% interest on the 189,500 (£473.75 in interest)? Well not exactly… Mortgage payments are fixed each month because of something called Amortisation which will be explained next.
Amortisation	This is what causes your monthly payment to be consistent over the life of a mortgage (assuming no changes in interest rate occur). Simply put, the principal and mortgage interest payments are divided in each monthly payment as a ratio that declines over time. As a rough example, your first monthly payment may be £1000. 40% of this value (£400) will pay off your principal and the other £600 will pay only the interest. Over time this ratio changes as you pay off the principal amount so that near the end of the mortgage you pay more of the principal than the interest ie. 90% principal payment and 10% interest payment at year 28 of a 30 year mortgage. In short most of the early mortgage payments you make are just paying off the interest on your loan and not the loan principal itself which is why overpayments are critical.
Term	This is the duration of the mortgage. Typically people get a 25 year mortgage however these can be longer or shorter. With the increasing house prices longer terms are seen with a rise in 30-40 year term loans.
Arrangement Fee	Can be zero fee or over £2000. This is the fee to complete a mortgage application and can be paid separately or added onto the mortgage. See below for some further tips.
Booking Fee	An application fee that some mortgage providers will charge just to apply for a mortgage with them. This can be a few hundred pounds though sometimes this is included in the arrangement fee.
Valuation Fee	You may choose to do your own survey to assess the property (there are a few options depending on how extensive you wish the survey to be) however, the bank will do their own survey to confirm the value of the property is equal to the loan. They will only look at the value of the property and not the problems that may be included with it. This can be free on some mortgages or they can charge up to £1500 on average for this. This can be added onto the mortgage cost so is worth confirming.
CHAPS (Clearing house automated payment system)	This is the fee that your mortgage lender charges to transfer the mortgage funds to your solicitor and is usually a maximum of £50
Early repayment fee	For most people this is not something that is considered but is important. This is the fee to repay your mortgage early either in full or in part. This is worth checking if you ever plan to overpay on your mortgage on a monthly basis. Some lenders will allow a certain percentage of the mortgage principal to be paid each year without a fee but some will charge up to 5% of the amount you pay extra. It is recommended to avoid mortgage providers that do this as you will be locked in to pay the interest for the full mortgage term and repaying will cost you the same, if not more, than just making the normal payments each month.

TIPS Section

There are some recommendations to be made for the terms above and mortgage in general.

Down payment	I would advise getting as much of a deposit as possible but 10% should be an initial goal. Understandably this is a large amount to many people however the benefits of 10% is that this is often an optimum down payment for the lowest interest rate. Below 10% the interest rate gets much larger but above 10% the drop in interest rate becomes less significant unless you reach the big whole numbers such as 20%, 30% and 40%.
Interest	When thinking about interest it is important to think about this only being valid for a few years. UK mortgages are limited in terms of fixed interest with 3-5 years being most available however recently some providers are increasing this to have a fixed interest for 10-15 years now. You may have a low interest rate that looks very affordable initially but this can quickly change especially in todays environment. 3 years may seem like a long time however in 3 years time you will be, most likely, switched to a variable rate which is controlled by the mortgage lender and influenced by the Bank of England interest rate. Your fixed rate 3% mortgage may very quickly double to 6%, or even higher, anytime after those 3 years depending on the economic environment. It is important to remember that interest rates can increase when considering fixed interest mortgages when the fixed year rate runs out.
Amortisation	This is important when thinking about overpayments which can be checked online here https://www.moneysavingexpert.com/mortgages/mortgage-overpayment-calculator/ . This can greatly reduce your interest payments and bring your loan to a shorter term saving you both money and ensuring you will have a home in your name.
Term	The term is an interesting one. The duration is always up to you with a maximum 40 year term possible however most go for a 30-35 year mortgage. This is affected by your age and how far you are from retirement age. In my experience a longer term works out better in almost all cases. A shorter term mortgage will increase your monthly payments but you can reduce monthly payments with a longer term and make overpayments to repay the loan faster. This way the additional payment is optional, allowing for more flexibility in your finances. It is important to consider early repayment charges in your mortgage as mentioned above!
Arrangement fee	These can be a bit tricky but a mortgage advisor can help point out the best deals. To get to the top of the recommended list, when doing an online mortgage comparison search, a lot of lenders will have this as a separate fee in order to keep the interest rate lower. When the fee is added onto the mortgage it typically will raise the interest so by taking this off it looks like the deal is better than it is and should you add this arrangement fee to the mortgage you may find the interest rate is higher than other mortgage lenders.

Hope this helps you a little bit to understand some terms while you search for mortgages. My next post will be a mortgage affordability calculator which will give you a good idea of what size of house you should be looking at and whether or not you can afford a change to your interest rate.

Stay tuned and check out some of our other posts in the blog!

Part 1: Start Saving Small – How to plan your finances

With inflation reaching all time highs not seen for decades, it is now more important than ever to plan out your finances. As a result I have put together this to help those that are struggling to get visibility on their income and outgoings by sharing how I manage my own. I know for many this a huge task and causes a lot of stress so I have tried to make this as clear and easy for many. I will also be posting a video for those that prefer to follow along visually without reading. This can be a great way to check your payslips so you can be share you aren’t overpaying when you shouldn’t be.

All of the below is focussed on UK tax laws but the principals apply everywhere. None of this can be considered financial advice but this is how I manage my own budgets. If you want to make this a joint budget calculator with your partner you can copy the first 2 columns in the table below and enter each persons salary and tax bands though I find keeping separate budgets makes life easier overall.

The spreadsheet, explained below, is available here: https://docs.google.com/spreadsheets/d/159qN5FkvDbbBFEXynNjwZcta8ifzyIrT/edit?usp=sharing&ouid=100841825636158668949&rtpof=true&sd=true

You can download this by going to File -> Download. There are multiple options for file formats if you do not have Excel to use. OpenOffice is a free alternative to Microsoft Excel.

Snapshot of what a budget calculator would look like for someone who only needs to consider the lower tax bracket

The first block relates to salary. Where there are green boxes this just refers to an area to fill in yourself. As an example I put a salary of £26,000 annually before tax. The table below shows where your payslip information comes from and is important to understand where your money goes and how taxes work.

Salary / wage	Put your annual income before tax into this cell
Basic Monthly / Basic Pay	This is your salary divided by 12. What will appear on your monthly pay slips.
Hourly rate	This is important to understand exactly how much you get per hour. This can be a great way to budget yourself based on how many hours would I need to work to pay for something. This thinking really helps prevent wasting money by quickly working out if something is worth doing yourself rather than paying someone else (think DIY). I have this as = salary wage cell / 52 / Hours worked per week
Tax Allowance	Not every country will have tax allowances so you should check your own countries tax rules, but in the UK there is a tax allowance on earnings. In 2021/2022 this is currently £12,570. Meaning you pay no tax on the first £12,570 you make. Every £1 you make above this gets taxed at the tax rate (currently 20%) until the next bracket is hit which this year is at £37,700. Example: If you make £40,000 then you will not be taxed on the first £12,570; be taxed at 20% on the next £25,130 (taking you to £37,700 total); then taxed at 40% on the next £2300 (taking you to your £40k salary). The link is at the bottom of the page for the gov site to review each year as this changes.
Taxed on	This is the proportion of your salary a month that gets taxed by the income tax. In this case only the 20% tax on additional money over £12,570 applies. An additional formula applies here for anyone who makes over £37,700 a year which is included in a second link for a spreadsheet at the bottom of the page. = Basic monthly – (Tax allowance / 12 (months)) – (any extras that come out before tax ie pension, student loan, cycle 2 work schemes etc which are covered below)
Tax Paid	This is the taxed on cell multiplied by the tax you pay on that income. In this case 20%. =”Taxed on” cell value x 0.2
National insurance paid	This varies depending on tax year and in April 2022 will be increasing by another 1.25%. For 2021-2022 however this is similar to taxed on income. You do not get taxed on the first £797 per month but get taxed on additional income by 12% up to £4,189. Any additional income you make above £4,189 is taxed at 2% for National Insurance. Example: You make £2000 a month before tax. You pay no National Insurance on £797 of that £2000. You then pay 12% on the remaining £1203 (2000-797) leaving you with a national insurance contribution of £144.36 (1203 x 0.12 (12% in decimal form)) each month. Important: Using this method it really helps you understand the impact that government changes will have to your finances. If you take the 1.25% increase planned for April 2022 then in the example above your contribution would go from £144.36 a month to £159.40 a month. Leaving you short £180.45 over the next year.
Pension	Pension will of course depend on your workplace. I’ve estimated around 4% as this is quite typical for a base contribution. This comes out of pre tax salary so this is not taxed by income tax and as such can be a good place to store extra cash especially if you are moving into higher tax brackets. Speak with your employer to raise contribution amounts. =Basic monthly x 0.04
Student Loan	Student loan is more complex depending on when you studied. The spreadsheet has a Plan 1 student loan in place. This means any income over £1,657 a month has 9% taken off as a repayment fee. Plan 1 Example: If you make £2166.67 a month then you subtract (2166.67 – 1657) to give you 509.67. You then repay 9% of the 509.67 as your student loan giving you a repayment fee of £45.87 a month. For Plan 2: The same applies as plan 1 however the threshold is now £2,274. In this case if you made £2166.67 a month you would not pay anything back in student loans. For Plan 4: The threshold is now £2,083 however you now pay 15% back in student loans. So if you make £2166.67 a month then (2166.67 – 2083) gives you £83.67. So you then repay 15% of this leaving you with a student loan repayment of £12.55 a month. PLAN 1 =(Basic monthly – 1657)*0.09 PLAN 2 =(Basic monthly – 2274)*0.09 PLAN 4 =(Basic monthly – 2038)*0.15 There are links at the bottom of the page where this information comes from as well as how to know which plan you are on.

It is important to check in April if the values have changed. It is also good to understand the impact that government changes have to your finances by using this template to update values.

The table below is a good summary for the 2021/2 tax year. Be aware this changes every April.

Screenshot of the Gov income tax details for 2021/2

Bills and budgets

The next 3 tables I use for planning outgoings ie bills, loans, insurances etc. I filled it out with some examples but of course this varies depending on you for example you might not own a car or house therefore car payments and insurances relating to these do not apply to you (yet!).

Starting with the left table; I use this for my fixed bills that I cannot just cancel (mortage/rent) or get rid of without being very risky (insurances). Most explain themselves. Things like a TV license are in here if you watch Freeview TV (in the UK) or subscribe to a TV package as these are legal requirements. I will likely do topics in the future on each item where good advice is available on bringing some of these costs down.

The most important topic in this left table is insurance. This is one of the most important ways to manage risk and prevent bankruptcy.

The middle table is what I use for Non-fixed bills and services. These are either fixed recurring, or annual, payments such as Netflix, Amazon Prime and Microsoft Office for example or they may be credit card debt that may vary each month. The services I have added are mostly nice to haves but depending on your circumstances could be cut out of your bills.

A good tip is to pay the annual fee instead of subscriptions including annual car insurance rather than the monthly payment as this avoids any added interest. So you can take the annual one time fee and divide by 12 and budget this into your monthly payments that way on renewal you have the money saved already.

The third table is arguably the most important one. This is where I add the topics I plan on budgeting for as explained below.

Food	I put quite a large amount in here for one person (if you have kids this may seem low) per month as it includes going out a couple times a month. This varies a lot but my personal spend is quite accurate now as I have been recording each month how much I spend so I can be confident (excluding events like christmas) how much I need each month.
Petrol / Diesel	Unless you have an electric car then you will need to consider Petrol / Diesel budgets. This is usually quite predictable each month as filling your car is usually 2-3 times a month. In the future I may do a cost comparison of buying an electric car vs typical combustion engine car but this may take some time as there is a lot of variables to think about.
Investing	NOTE: If you do not have savings already it is a good idea to have 3 months salary saved up at an absolute minimum (or whatever you may need to survive 3 months) for emergencies before investing everything. The split between investing and saving is up to you but without good emergency savings you will be more at risk. This is one of the critical steps to building savings. Typically most will store their money in the bank for bank interest however this interest rarely comes close to inflation which increases the price of goods and services each year. This means every year you may gain 1% in interest from your bank but if inflation is 5% for that year then you lost 4% of the money in your bank account (Potentially a similar thing to annual pay increases in your job). Ideally 20% of your total monthly salary after tax, pensions and student loan should go into investments. This may be difficult for a lot of people but it is important to try to get as close as possible to this value. The example shows a 10% investment each month but even 10% a month will put you in the right direction to getting on top of your finances and building good habits even if it may be hard at first. The easiest for most people will be having a stocks and shares ISA. This allows you to put money in (up to a certain annual amount) without being taxed on any profits you make. The easiest way, for a beginner, in these ISA accounts is picking reliable and safe ETFs or Mutual Funds (which are bundles of stocks around a specific topic such as S&P 500, technology, growth stocks, dividends etc) to invest in. These have very low entry requirements as you buy portions of shares rather than whole numbers (so you don’t need to have £1000 to buy one share of Tesla). There are many investment types such as stocks, real estate, art, wine, classic cars etc so owning a wide range of these is preferred should big changes occur in certain investments (2008 real estate market crash for example). This is too big of a topic to cover in this post alone so hopefully I will be able to give more detail on these if there is demand for it.

The final cell in the bottom right just totals up these 3 columns to tell you how much of your salary each month will go to bills and services.

The final table is the one off costs and the “total left” value. The “total left” value comes from the totals from the first 2 columns regarding salary minus the total of the 3 centre tables for bills and budget. So in the above example this is £1672.44 – £1,589.36. Giving us the £83.08 left each month. This is where one off costs get accounted for such as needing some new clothes. The main focus of this cell is save whatever is remaining each month. If I don’t have to use this remaining money I won’t. In this case I will transfer this to a savings account as backup savings for important occasions / travel / date nights etc.

I would like to end this hoping you all manage to get through any difficulties you may have ahead. If this did help you out I really encourage you to share the information and help someone else you know. Helping someone else will always make both of you stronger in the long run and we need each other more than ever.

Later on I will put a post focussing on how to get rid of debt and what to prioritise. This is something I feel many people get wrong and they try to pay off the wrong debt first which only makes their situation worse. As well as a post regarding the importance of insurance.

LINKS BELOW

For taxable allowance you can see this link for the government document https://www.gov.uk/government/publications/rates-and-allowances-income-tax/income-tax-rates-and-allowances-current-and-past

To know what your student loan plan is see this link: https://www.gov.uk/repaying-your-student-loan/what-you-pay

To understand how much your student loan costs see this link: https://www.gov.uk/repaying-your-student-loan/what-you-pay

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