Affordability - what is it and why do lenders care?
Heard the word ‘affordability’ bandied about and want to know what it is? Well, we’re glad you asked, as it’s something that’s very important to lenders.
If you’ve ever been rejected for credit, it’s probably come down to one of two things – your credit score or affordability.
And the clue to what affordability means is in the name – it’s how much you can afford to borrow. Even if you have a great credit score, you’re likely to be rejected for credit if the lender thinks that you can’t afford the loan you’ve asked for.
I don’t get it
We understand it can be a little confusing. After all, if you were a millionaire who could afford to buy anything, why would you be borrowing anyway?
Well, it’s important to lenders that you can afford to make your repayments each month. It’s called ‘responsible lending’, and while you might think lenders care about nothing more than getting their money, in reality they don’t want you to be left struggling.
What can I afford?
Whatever type of credit you’re planning to apply for, you need to work out how much you can pay towards it each month.
It’s a good idea to work out how much you can afford to borrow before you apply, because the lender certainly will.
What will I be asked?
It all depends on what you’re applying for. A credit card with a limit of £2,000 is a very different beast to a mortgage of £250,000, after all. So, it’s hardly a surprise that the lenders offering the biggest sums of cash will question you the most closely.
For example, if you’re applying for a credit card, the lender will probably ask for your income, but they might not ask you to give a detailed breakdown of your spending. Lenders will often look at your take home pay, and use some average figures based on where you live and your household type (so whether you live on your own, for example) to estimate your spending.
Similarly, if you apply for a personal loan – lenders often use an automated process based on average spending across the UK. However, you may also find that some loan providers will either ask for recent bank statements, or speak to you to go through what you spend.
On the other hand, if you’re applying for a mortgage, well – you could be asked everything from whether you have a gym membership to how much you fork out to keep your barnet looking good.
So, do you like a spot of Netflix? You’ll be asked if you have a subscription. Attend a life drawing class? Or are you obsessed with building model railways? Or buying pink fluffy kittens on eBay? You’ll need to be sure you can afford a mortgage on top of your hobbies. Basically, if you spend any money regularly, lenders want to know about it –all so they can work out what you can afford to borrow.
Unless they’re sure that you can afford your mortgage each month on top of what you’re already spending – or you’re willing to sacrifice some of your current spending commitments – you’re unlikely to get the mortgage you want.
Before you apply for credit of any sort, it’s a good idea to review your budget. You can use an online tool like this, or just an old-fashioned pen and paper to work out where all your money goes. If you find you are already spending every penny you earn, it’s probably time to have a honest talk with yourself about what you’d have to give up to cover the repayments if you were to borrow.
So there you have it – what affordability is, and why it matters.
Disclaimer: All information and links are correct at the time of publishing.