How to calculate a loan-to-income ratio and understand how lenders assess the results

Lenders, particularly mainstream mortgage providers, will examine how to calculate a loan-to-income ratio to determine how much they can lend to borrowers. A loan-to-income ratio, from a borrower’s perspective, is the amount they want to borrow divided by how much they earn.

In addition to calculating the loan-to-income ratio, lenders may explore a borrower’s debt-to-income ratio. This reflects how much of their monthly income a borrower spends on paying off existing debts, such as credit card debt or personal loans.

Though criteria and assessments between lenders will vary. Most have capped their loan-to-income ratio at 4.5x a borrower’s income. However, in recent months, we’ve seen some notable shifts on the high street. Your clients will need to be aware of how the changes may affect their property investment plans.

Source: Online Mortgage Advisor, Equifax

How to calculate a loan-to-income ratio and what actually counts as income

Calculating a loan-to-income ratio is straightforward. Basically, you take the amount you want to borrow, and divide it by how much you earn. The result can’t be above the lender’s capped threshold.

For example, your client wants to borrow £100,000 and earns £50,000 a year.  Therefore, the calculation would be: 100,000 / 50,000 = 2. Most lenders would be happy to lend off this result, so long as the borrower ticks all other criteria.

Where things get can get complicated is incorporating all the elements that count as income. Your client’s salary will likely make up the bulk. But you’ll also need to think about overtime income, bonuses, pension benefits, dividends, state benefits, and more.

Each lender may place varying levels of importance on supplemental income sources. Some may take 100% of your client’s bonuses into account. Others may only factor in 50% of them, for example.

And for each source of income factored in, lenders will want to see evidence such as payslips, reward letters, P60s and more. If your clients aren’t on top of their paperwork, it could slow their progress down.

Source: Online Mortgage Advisor

The challenge with non-typical incomes

What’s more, the question of how to calculate a loan-to-income ratio may be rendered moot for investors without a regular 9-5. Given the challenging market we’re facing, many mainstream lenders have tightened their criteria in recent months. Those with relatively unique or sporadic income sources are struggling to get by.

According to The Mortgage Lender (TML), over a quarter (28%) of adults with non-typical income streams have had a mortgage application rejected by a lender. This included those who are self-employed, freelance, or work on zero-hours contracts.

The calculation could be made even more complicated by overseas income and/or foreign assets. Generally, the more complicated your client’s situation, the more difficult it may be to get by on the high street.

Source: Financial Reporter

Loan-to-income ratios in the current market

Actually, some banks are becoming more accommodating in how they calculate loan-to-income ratios. In recent months, we’ve seen several mainstream names raise their loan-to-income limits to 5.5x or even higher.

Some commentators believe loan-to-income ratio tweaks will become more common as lenders battle for business and court borrowers. But, given our current period of high inflation and economic instability, some fear raising borrowing limits could be dangerous.

Also, when you bear down into the details of some of these increases, limiting caveats may still apply. Take a recent example from a well known building society, which raised its maximum loan-to-income ratio to 5.5x.

Its new loan-to-income increase would only be applied to households with a gross annual income of over £75,000. However, the median annual pay for full-time employees was £33,000 for the tax year ending 5 April 2022. Therefore, several first-time buyers or small-scale investors may not be able to benefit from these kinds of increases. Nevertheless, these changes are hugely beneficial for certain parts of the market. And innovation is always welcomed.

Source: Mortgage solutions, Mortgage Strategy, ONS, Mortgage Solutions, Mortgage Strategy

How do we factor in loan-to-income ratios?

Across our bridging products, funding is secured against property – the building invested in, or an existing asset. Specialist finance can support property investors who may not have high levels of income, or who have unique income sources.

Our funding is for foreign national buyers, the self-employed, seasonal workers, or anyone else who may struggle on the high street.

However, what’s important to us, is that the properties your clients are investing in hold potential. And that there’s a clear exit strategy at hand. We’re able to work with property investors purchasing a HMO with plans to move onto long-term finance, through to fix-and-flip buyers who want to sell the asset in the short term.

If you’re concerned about the how to calculate loan-to-income ratio question and what it means for your clients, we’re here for you. We’ll answer any questions you may have within 4 hours of a query, and we’ll assign you a dedicated underwriter from day 1.