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Struggling to buy a home? Long-term mortgage may suit those who cannot pass income rules

A long-term mortgage may suit those who can’t pass the Central Bank’s stress test

With house prices continuing to rise, maximising your loan – in an affordable manner, of course – has become increasingly important. Having an additional amount to play with may mean the difference in securing your home or not.

This has been one of the criticisms of the Central Bank’s strict income multiples under its macroprudential rules, in that it is too restrictive in terms of how much it allows people to borrow. However, the rules are not the only thing that impact and, in some instances, people can’t even qualify for the maximum allowed under these rules.

Here we will look at how the introduction of long-term mortgages may help you qualify for a larger home loan.

Getting a mortgage

There are two main ways lenders can determine how much they can lend to a borrower. Firstly, they are bound by the Central Bank’s macroprudential rules. And secondly, on the borrower’s repayment capacity or PRA (payment repayment ability).

“And they’re both equally as important,” says Michael Dowling of mortgage broker Dowling Financial.

On the first point, lenders must make sure a borrower stays within the prescribed income multiples of 3.5 times income, joint or otherwise, unless they are granting them an exemption.

So someone earning €40,000 can borrow €140,000, if borrowing alone, or a couple with combined income of €120,000 can borrow €420,000.

But to get that mortgage approval letter they will also need to pass a further hurdle by showing they have the ability to service the loan each month.

Not only that, but they must also pass a so-called stress test, under Central Bank rules. This involves testing whether or not a borrower will be able to afford to repay the loan should interest rates rise by 2 per cent, “at a minimum”, above the rate that is being offered to them.

And this test can hurt. “It means if you have other debt that sometimes can reduce your repayment capacity,” says Dowling, meaning that this can impact the ultimate amount of a mortgage you may qualify for.

Stress tests

Consider EBS’ approach. For its stress test it uses a rate of 2 per cent above its standard variable rate of 3.7 per cent, so an interest rate of 5.7 per cent then. The purpose of the test is to make sure there will be enough left in your bank account after all your expenses, and after your future mortgage repayments have been factored in.

The lender is quite specific at the amount of income it wants to see left behind each month. A couple with children should have €2,300 left in their bank account after all other expenses (such as childcare, food, bills, etc) have been deducted, and after their future mortgage repayments have been factored in. Couples with more than one child will need an extra €250 for each thereafter.

Single applicants need to have €1,400 left in their bank account after all other expenses and future mortgage repayments have been subtracted.

So a one-income couple earning €50,000 can borrow €175,000 as per the Central Bank’s lending rules. On an income of €50,000, they have a monthly after-tax income of €3,067, while their mortgage repayments will be €737.81, based on an interest rate of 3 per cent. With no other expenses, they will qualify for the €175,000 mortgage, as their income meets the €2,300 required balance.

Once the loan is stress tested, however, they will struggle, as they will only be left with €2,051 a month, which isn’t enough to meet EBS requirements.

Similarly, a single applicant on €30,000 should be able to borrow €105,000 under the Central Bank rules. On such an income, they will earn €2,121 a month after tax, and with monthly mortgage repayments of €442.68, a personal loan of €200 a month, they are doing okay by the bank’s €1,400 limit.

However, when the application is stress tested to 5.7 per cent, repayments jump to €629 a month, which leaves them short of the €1,400 a month required by the bank.

Long-term mortgages

But there is a way of getting around these stress tests – by opting for a long-term mortgage. After all, if these applicants didn’t have to satisfy stress tests, they could have borrowed the full amount allowed by the Central Bank rules.

This is because, according to the Central Bank, such stress tests don’t apply where mortgage products are fixed for five years or more.

So, should you lock in for this term or longer, your lender won’t be obliged to stress-test your capacity to repay your mortgage in different interest rate scenarios.

And what this means for you, is the possibility of a larger loan.

Consider Avant Money’s just launched 30-year “One Mortgage” product. The interest rate on this loan is fixed for the entire term, which means stress tests won’t apply, and applicants will have the certainty of the same interest rate over the life of the loan.

Let’s take two applicants, with joint household income of €86,000, looking for a €300,000 mortgage over 30 years, based on a loan-to-value of 75 per cent.

With childcare costs of €1,500 and no other loans, they could borrow €300,000 with the 30-year product. However, opting for a term of under five years – and therefore facing stress tests – will mean they can only borrow €274,000, or 9.5 per cent less, and just 3.1 times their income, according to Avant Money.

Longer-term mortgages, of up to 10 years, have been in the Irish market for quite some time. What has changed of late, however, is not only have they become more competitive, but they also offer greater benefits.

In May, Finance Ireland launched a range of new long-term loans, of 10, 15 and 20 years, with rates starting at 2.85 per cent based on a loan-to-value ratio of 90 per cent. A spokesman confirms that stress tests don’t apply to these terms.

Meanwhile, Avant Money’s aforementioned new 30-year loan has a rate of 3.1 per cent for those looking to borrow 90 per cent or more of the purchase price of their new home.

The Spanish-owned lender has made a strong impression on the Irish market since launching last September, and already has about a billion euro in mortgage applications, and expects this to reach about €1.5/€2 billion by the end of the year.

Downsides of fixing for the long term

As a caveat, while you may be able to borrow more by virtue of borrowing over a longer period of time, and you may also be attracted by the certainty a longer-term loan gives you, there are some negatives you should consider.

First of all, your mortgage could ultimately end up costing you more – after all, rates might fall further yet, we just don’t know.

Other downsides of long-term mortgages have been mitigated by the latest launch of new products.

When it comes to overpaying your mortgage, for example, both Avant Money and Finance Ireland will allow you to overpay up to 10 per cent of your outstanding mortgage balance as a lump sum each year.

Fixing for so long also reduces options for switching, or repaying your mortgage if you move home, as leaving a fixed-term early incurs a break fee, which can be significant.

One feature of Finance Ireland’s 20-year loan is that you will be able to bring the loan with you. With Avant Money, you won’t have this option; instead, a break fee of 2 per cent of the outstanding balance of your mortgage will apply if you repay your mortgage early. If, however, you are moving house and taking out a new mortgage with Avant Money, you may be entitled to a refund of this fee.

Typically, you also won’t be able to lock into lower rates as your loan-to-value ratio drops. Again, a special feature of the Finance Ireland product allows your mortgage rate to reduce, even though you’ve locked into a fixed rate. This is because it will fall to one of the lower rates available for lower loan-to-value ratios.