Affordability is simply the ability to pay back a loan. It has rightly become one of the most important parts of the underwriting process in recent years.
How affordability is calculated
Affordability is calculated by taking your total personal income and subtracting your total fixed expenditure. The amount you are left with is your disposable income in which you need enough to meet your new loans repayment. An simplified example of this could be:
|Car Running Costs||£100|
This example gives a disposable income of £975 per month, so if the prospective loan repayment was £200 per month the lender would certainly be happy the the loan was affordable for you. If however it was a lot closer, and perhaps the disposable income was £250, then the lender would need to make the decision as to leaving you with £50 disposable income after the new loan is a responsible thing to do.
Every lender calculates affordability in different ways, but they all do it. If your income and outgoings leave you with not much left over, you may want to see if there is perhaps an alternative way to source the money you need – or look at a consolidation loan to decrease your monthly commitments.
Savings can also be taken into account when looking at affordability, however if you have savings you may be in a better position to spend this rather than taking out finance.
Proving your income
Part of affordability is proving your income. Luckily a lot of lenders make this very simple through electronic means and automation. There are ways for lenders to confirm your income in a similar way to a credit search. Banks share information about your income with credit reference agencys so if your income is stable, and it all goes through your bank, you may get lucky and not have to provide any paper documents to support your application.
However, if the automated checks fail, or the lender does not use them, you will most likely be required to send in a recent payslip or bank statement to prove your income. This is a simple process and can generally be faxed, scanned, photographed, posted directly to the lender.
Debt to income ratio
Another part of affordability is your debt to income. This is the amount of debt you have to repay monthly vs your gross income (before tax). So for example:
|118 118 Money Loan||£150|
|Gross Monthly Income||£1,500|
Now let’s work out your debt to income ratio. We take your total debt payments (£990) and divide it by your gross monthly income:
900 / 1500 = 0.6
You then multiply this by 100:
0.6 * 100 = 60
This gives you a debt to income ratio of 60%, which while not really bad (think 80%+) this could cause you some problems when accessing finance. Ideally you would want to keep your ratio under 50%, you can do this by either reducing your amount of debt, or increasing your income (easier said than done I know!).« Back to Glossary Index