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How repaying capital affects mortgage affordability


Published: 26 June 2012 | Author: Bernard Clarke

Our mortgage lending data now includes additional information on the cost of monthly repayments for borrowers. As well as reporting the proportion of income the average borrower pays in mortgage interest, the data now also shows the combined effects of capital-and-interest payments.

For some years, we have only reported interest payments as a proportion of income in our affordability figures. Interest is, of course, an element paid by all home-buyers. We chose not to show capital-and-interest payments because, until recently, a large proportion of borrowers took out interest-only mortgages and so did not make contractual monthly capital repayments. 

In recent years, however, there has been a change in lending behaviour. Most movers (85%) now take out a capital-and-interest mortgages, while for first-time buyers the proportion has risen to 98%. In our April mortgage lending press release, we therefore included for the first time data on the capital-and-interest payment burden, as a proportion of income.

We have back-dated this new information to 2005 in the tables of data we continue to publish each month. However, our run of data showing the proportion of borrower’s income paid in mortgage interest (that is, excluding capital repayments) goes back to 1974. From now on, our tables will include both measures of affordability. 

Different measures of affordability will produce different results at different interest rates. Today, we are publishing some examples to show the effects of this.

The unprecedented low interest rate environment in which we are currently operating has made mortgage affordability much better for those able to overcome the deposit hurdle. We have been able to report for some time that, according to our comprehensive regulated mortgage survey, borrowers pay less of their income to meet their mortgage interest payments than at any time for nearly a decade.

But for borrowers with repayment mortgages, monthly capital repayments make up a significant additional element of the overall mortgage burden. As Chart One shows, although interest payments currently account for less than 13% of a typical first-time buyer’s income, the inclusion of capital repayments raises the total payment burden to nearly 20%.

Chart One: First-time buyer mortgage payments as a percentage of income

Source: CML Research

Chart One also shows that this difference between total payments and interest-only payments has widened in recent periods. Both interest payments and total payments have fallen, but the total payment burden has fallen by a smaller amount. The reason for this is that, as the interest rate falls, the proportion of capital repaid each month rises – within a lower overall total payment. Table One shows how total annual mortgage payments for a typical first-time buyer would be affected by different interest rates.

Table One: Interest-only versus capital-plus-interest payment illustrations


Source: CML Research    

1. Calculations based on a mortgage of £115,000, borrower income £35,000,
paid over a 25 year term (typical recent first -time buyer characteristics).

As we can see here, and in Chart Two, an interest rate of 6% accounts for some 20% of borrower income on an interest-only basis, while capital-and-interest payments account for 25% of income. But at a lower 3% interest rate, interest payments reduce dramatically – to just 10% of income – while capital-and-interest payments decline only to 19%. In effect, borrowers with a capital-and-interest mortgage repay their outstanding debt more quickly when rates are lower. However, at much higher interest rates – for example, the 15% charged on new mortgages in 1981, the capital repayment element at the start of a mortgage is dramatically lower, meaning there is little difference between the monthly mortgage payment burden, whether a borrower is on an interest-only or capital-and-interest basis.