What do we mean by disposable income and how should you treat this income? Well disposable income, otherwise known as disposable personal income (DPI), is the amount of money that households have available for spending and saving after income taxes have been accounted for.
Disposable personal income is often monitored as one of the many key economic indicators used to gauge the overall state of the economy.
When a lender completes their affordability assessment they will have an idea of how much they think you can afford on a monthly basis. This is rarely the same as how much you might think you can borrow. Often, people renting, will say that they can easily afford a mortgage payment similar to what they are paying in rent. They are then surprised when a lender or their adviser says that the amount a lender says they can afford and therefore borrow, is less.
‘But how can this be, you can see we are paying that much now easily?’
Part of the reason for this is that the lender has to demonstrate they are lending prudently and also have to take into account the impact that a future rise in interest rates may have. Essentially they are determining not just what you can afford now but also in the future if rates were to increase.
What is Disposable Income?
Turning back to the disposable income figure. The first thing we want to say is that this is not a target. The aim of arriving at this figure is not to then necessarily utilise this for the purposes of a monthly mortgage payment and/or protection costs. Instead, this figure should be used as a guide e.g. how much do we have left at the end of each month to accommodate our mortgage payment and possibly protection costs. Room should be left to allow for unforeseen costs (a washing machine needs replacing for example) as well as looking to build an emergency fund through savings e.g. using 60% of your realistic disposable income for your mortgage and insurance costs leaving 40% to be retained for ‘a rainy day’.
Additionally, we touched on the impact of a rise in interest rates. We continue to be in a period of low-interest rate lending and currently, when this will change, is still somewhat unknown. With so much happening in the world, we would not be prepared to say if and when mortgage interest rates will substantially increase. That being said, a good mortgage discussion should not just explore what the mortgage payment would be on any initial product rate e.g. a fixed rate, but also what the payment will revert to at the end of that and the impact of a rise in interest rates in the future. A mortgage may be in place for 25 years so what is affordable now should ideally remain affordable until that debt is repaid and not using 100% of your disposable income at the start may prove wise in the future.
*Your home may be repossessed if you do not keep up repayment on your mortgage.