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Know your Borrowing Power: Affordability and your disposable income

When it comes to borrowing money, it can be difficult to know you’re getting the best deal available to you. That’s why we created Borrowing Power. It gives you a 1-10 Zopa rating that gives you a clear picture of your financial health, along with tailored recommendations of how to improve if it needs a little TLC. Even better, it shows you which rates you could borrow at with Zopa, and the rates you could unlock if you manage to improve your Borrowing Power. Representative APR 9.9%. 

Lots goes into calculating that rating, so we’ve asked Laura Whateley, award-winning financial journalist and author of Money: A Users’ Guide, to explain some of the key factors that affect it.  

You may feel confident that you can easily pay back a loan or mortgage, but whoever you are asking to borrow from will want to make up their own mind by judging what is known as your “affordability”. 

Responsible lending 

Since the financial crisis and credit crunch when people lost their homes and fell into debt because they had been sold unaffordable loans, this has become more important than ever.  

Banks, and those who regulate them, do not want to lend to people they fear will be unable to repay their loans now, or in the future, if circumstances were to change.  

Assessing whether a loan is affordable 

Lenders will look at a whole range of “affordability indicators” to determine your ability to keep up repayments in the event of any “future shocks”.  

Can you meet your required payments? 

Financial services regulators say borrowers need to be able to make required repayments on a loan without difficulty, while continuing to meet other debt that they may have on top of normal outgoings.  

Can you pay off your debt in a reasonable time? 

The debt needs to be repaid within a reasonable period of time, using your normal income and savings, not more debt. It is no longer ok to offer someone credit on the basis that they can service the debt over years by chipping away at minimum repayments.  

Is your disposable income changing any time soon? 

When deciding whether to lend to you, banks will consider your credit file as well as looking at your disposable income and your likely future disposable income – is that likely to change? Are you about to have children, for example, or switch jobs that means your income will take a hit?  

Does it fit with your other financial commitments? 

They will also consider your financial commitments, that is stuff you regularly pay for that you can’t afford to skip: rent, or your car, council tax and utility bills, even gym membership or dog food. They will also consider other debt that you have and how much of your salary is spent paying it off.  

Do you meet affordability assessments? 

If you are applying for a huge loan in the form of a mortgage, affordability assessments are vital. Where in the past your salary alone was enough to determine how much you would be allowed to borrow, now your outgoings and credit history are just as important. 

Banks will also “stress test” applicants. Lenders’ interest rates are based on the Bank of England base rate. This has been at record lows for several years. If it rises, so will the cost of loans and mortgages, which if borrowers have stretched themselves too far could leave people unable to meet the cost of their monthly repayments.  

That’s why banks now assess how much you can borrow not just on the cost of repayments, but also on what you could afford if interest rates rise. You will only be able to borrow as much as you can happily afford with an interest rate of 3 per cent higher than it is today, usually compared with a bank’s standard variable rate.  

Getting a clear picture of your finances 

If you’re about to apply for a loan or mortgage, bear in mind that a lender may want to see three month’s worth of bank statements to get a clear picture of your income and outgoings. Trimming back your spending and clearing as much debt as you can will help improve a lender’s view of your affordability, as the more you are already paying out, the less you will be seen as having tolerance for more credit.   

Laura Whateley is a freelance writer and author of Sunday Times bestselling book Money: a user’s guide. She has written for a wide variety of publications including The Times, The Guardian, Grazia, Refinery 29, Elle and Stylist Magazine. All views are her own.