What does affordability mean?

So you’ve decided what you need from your next car. Enough room for both kids and a big shop, with Apple Carplay to keep everyone happy on long road trips. However before you start scouring the forecourts and furiously Googling boot sizes, you need to work out how much you can afford to pay for your new ride. There aren’t many things more soul-destroying than finding the car of your dreams and then realising it’s beyond your budget.

If you’re planning to take out car finance to pay for your new wheels, your lender will need to take a view on what you can afford too. Let’s check out how it works.

What is affordability and how does it affect car finance?

Affordability means taking a broad look at your finances - including your income and the main bills you already have, like your mortgage or rent - to see how comfortably you could potentially manage monthly car finance payments.

Lenders have a duty to check your affordability before they offer you a loan - it’s part of responsible lending. It’s an important step in the process, designed to make sure you don’t bite off more than you can chew. No one wants to end up borrowing more than they can manage, and ending up in financial difficulty down the line, struggling to keep up with their payments. Plus, lenders need to be reasonably confident they’ll get back the money they lend to you, plus a little interest on top.

How do lenders assess affordability?

When you apply for car finance, you’ll need to answer some specific questions to help the lender figure out if you can afford to pay back the loan. To do this, they need to know how much money you’ve got coming in, and how much money is going out.

You’ll be asked about your monthly income, including your salary and any other income you might get from savings, investments or rental properties. You’ll also need to tell the lender about your major regular outgoings - this normally includes your monthly mortgage or rent payments, plus things like childcare or child maintenance if you’re a parent.

This information will give the lender an idea of your disposable income - that is, how much money you have available to spend on non-essential stuff. Although to be honest, that Netflix subscription and morning latte feel pretty essential, right? The more disposable income you have, the more likely it is that you’ll be able to comfortably afford car finance repayments, and the lender will see you as less of a risk to lend to.

How does an affordability check work?

Affordability checks are split into two parts - the money you have coming in, and the money you have going out. So, lenders will look at both sides of the coin (no pun intended).

Your income

If you’re employed, you’ll need to provide proof of income, whether this takes the form of allowing them to contact your bank to check it directly, reviewing payslips (usually three months’ worth) or with a P60. If you receive any benefits or other types of income, this counts as well, but you’ll need to back it up with paperwork, like bank statements, to show how much you’re earning.

If you’re self-employed, the lender might be a bit more picky about this, especially if your income changes from one month to the next. So you might find that you have to provide tax returns from over a longer period of time, to give the lender a better idea of your overall financial situation.

Your outgoings

Once the lender has a clear idea of how much money you have coming in, they’ll look at how much is going out. This means they’ll look at all your essential bills, including your rent or mortgage payments, council tax, utilities, food, clothes and insurance. It may feel like they’re being pretty nosy, but it’s all for a good reason - the purpose of an affordability check is to make sure you can manage your repayments, so you don’t end up with money troubles later on.

At this point, the lender will take a look at your credit report too, so they can see how much of your money is going towards repaying any debt you already have.

When they have all this information, they can tot it all up and figure out how much disposable income you realistically have. This will then give them a decent idea of your financial situation and, crucially, what you can afford to borrow for your new ride.

What factors affect car finance affordability?

As well as your personal financial circumstances, including your income and outgoings, there are a few other things that can affect your affordability.

Interest rates

The higher the interest rate the lender offers you, the more you’ll have to pay for your car finance.

Loan term

A longer car finance agreement usually means the monthly payments will be lower, but you’ll pay more in interest overall. A shorter term comes with higher monthly repayments, but it won’t cost as much overall because you’ll pay less in interest.

Deposit

The amount you can put down as a deposit has a big impact on affordability, because the deposit amount is taken off the total loan amount. So, the bigger the deposit, the smaller the balance left to pay off, and the lower the monthly payments 

It’s worth bearing these things in mind when you’re figuring out your budget for your new wheels.

What can I do to improve my affordability?

Before you take the plunge and apply for car finance, there are a few things you can do to give your finances some TLC and boost your affordability.

Budget

Sit down to draw up a realistic budget, and don’t spend more than you earn. This will help you manage your finances, as well as showing the lender that you’re financially responsible (just the kind of customer they like!).

Be flexible

A lender may not want to lend you the amount you want, based on affordability, but they may be willing to offer you a lower amount, or a longer repayment term. It’s worth considering different types of car finance plans so you can go for the most affordable option for you.

Cut back in other ways

Check your budget, and go through everything you’ve spent in the last few months. Is there anywhere you could cut back or tighten your belt, to give you an extra bit of wriggle room in your budget? Remember, the more disposable income you have available, the better your chances of passing an affordability check.

Pay down your debts

If you already have some debt, such as a credit card balance or another loan, do your best to pay off as much as you can. The less debt you have to repay, the more disposable income you have, which means better affordability for car finance.

Stress-test your finances

Remember that the point of an affordability check is to protect you, just as much as to protect the lender. Even if you can comfortably afford car finance repayments now, it’s a good idea to think about whether you could manage in the future if something unexpected happened, like losing your job, or having to deal with a big unexpected bill. Do you have a cushion of money in case life throws you a curveball?

What steps can I take to budget better?

Managing your money responsibly is really important, especially if you’re eyeing up a new car, and want to be able to take to the open road with no faff. Here’s a few things you can do to get on top of your finances, and put yourself in the best position possible before applying for car finance.

Know how much is coming in

Your income is the foundation of your budget. This will be quite straightforward if you earn a regular monthly salary, maybe less so if your income fluctuates from month to month, perhaps because you’re self-employed, or if you get your income from other sources like benefits, savings or investments. Check your bank statements for the last few months to get as clear as you can on how much money is coming in every month.

Know how much is going out

The next step is to know how much is going out. Start with your fixed outgoings - your regular bills like your rent or mortgage, insurance, and any other fixed payments. Then look at the things you have to pay for, but not always the exact same amount - the regular food shop, utility bills, that sort of thing.

Track your spending

It can be hard to keep track of where the money goes, so it’s a good idea to make a conscious effort to track your spending. It’s up to you whether you use pen and paper, make notes on your phone, track everything in a spreadsheet or use one of the many, many apps out there designed for this very purpose. Tracking will help you see where you’re spending your money, and help you spot any opportunities to cut back, if you need to free up some disposable income.

Adjust your spending to stay within your budget

Once you know how much is coming in and how much is going out, you can adjust your habits to make sure you’re not spending more than you earn.

Review your budget regularly

Nothing stays the same forever, so it’s a good idea to review your budget every so often to make sure you’re on track. Once you’ve got a budget to work with, it should be easy enough to tweak it or make adjustments here and there if, for example, you get a pay rise, or your regular outgoings change.

Budgeting and sticking to a plan for your finances will help you feel in control, and show lenders that you can manage your money responsibly. And that is a really, really good feeling to take with you when you start visiting dealerships to upgrade your ride.