Rent v mortgage payments. Why it’s time to rethink affordability

The last decade has seen a significant amount of change in the world of mortgage lending, a level of change few financial industries have experienced. Mortgage lenders have paid attention to the emphasis on affordability demanded by the Mortgage Market Review, looking far beyond deposits and earnings when it comes to making a lending decision. Decisions are made on the basis of how a borrower can be expected to maintain monthly payments in the long-term.

It’s not the rules of engagement that are encouraging the change which could alter the decisions made by lenders, but rather the information itself which is used to inform them. Research conducted by Experian looked at the relationship between rental rates and the average monthly mortgage payments a first-time buyer could be expected to make across the UK (based on the average rate on a two-year fixed rate mortgage, assuming a 90% loan-to-value over 25 years).

Rental payments were either less than or within 10% of the monthly payments someone could expect to pay on a mortgage in 27% of districts. With 4.3 million private tenants in the country, it appears many would find monthly mortgage payments manageable and comparable to what they currently pay in rented accommodation, assuming they could finance a deposit.

While this is interesting it’s perhaps not surprising given the backdrop of increased demand for rental properties and the low interest rates lenders are currently offering. But how should this changeable information shape how lenders make their decisions?

It’s logical to come to the conclusion that a would-be first-time buyer who has paid rent reliably for a number of years should be a solid candidate to behave in the same way with mortgage payments at a similar expense. Experian has developed the Rental Exchange to give lenders the opportunity to validate these payments, and factor it into their thinking when they consider what constitutes an affordable monthly rate.

If the present trend can be used as a guide, then rental payments can continue to be a good benchmark for years to come. We found that in more than a third of districts the cost of renting increased, while the typical monthly cost of a mortgage fell year-on-year. The reverse was true in just 4% of districts. While it is still less expensive on a monthly basis to rent than buy in the majority of districts, the gap is closing.

There are other elements which could shape how lenders work – whether interest rates will remain low in the medium-term and reflect kindly on homeowners, whether an increase of new build homes will meet the demand and bring more affordable options to the market, and whether creative homeownership solutions will help first-time buyers build the funds needed for a deposit.

All these points are crucial to the affordability decisions lenders must make. Lenders should take all of the information available today to make responsible lending decisions in the long-term. By considering an applicant’s track record of rental payments, lenders can get a 360 view of a borrower’s financial situation, helping them draw the most accurate conclusions on how they will handle monthly mortgage payments.