When looking to buy a new home inevitably one of the first questions asked by clients is “how much CAN we borrow?”. This information is used to work out what price bracket they can look at. But just because you CAN borrow up to a certain amount – should you?
In days of old, Credit (even just for a hire purchase) was difficult to get. Then we had the time of excess where Lenders were falling over themselves offering “Easy Finance”. Some lenders didn’t even care if the client could really afford to repay the loan. With the Global Financial Crisis slapping Lenders in the face we saw a return to the strict guidelines of old. Now in the aftermath of the GFC - we are again seeing a relaxation of lending policy.
Previously most lenders based their servicing (debt repayment) policies on a percentage of a person’s income. They would want to see that the loan repayment would be around no more than 30 – 35% of the gross annual income. Today lenders generally base it on a surplus. They will estimate a certain monthly amount that a person would need to live off and anything left over can be used to repay debts. Sometimes that can see the amount spent on debt go well over 50% of person’s income.
But is simply working off a surplus such a bad thing? On paper probably not. But in reality we find nearly everyone underestimates how much they need to sustain their lifestyle when they purchase a new home. So they purchase the maximum level that they can get finance for only to find out that they have to change their lifestyle drastically to accommodate the new outgoings. The novelty of that new home can wear off pretty quickly making the new dream home a mortgage nightmare.
Our recommendation is to work out a budget based on your lifestyle. Have categories like the “basic necessities of life” such as food, power, phone, rates, insurance and use what you spend on these items. If you spend $300 week on groceries put that figure in – not the figure of some frugal relative offering advice as to what you should be spending on. Then have the things that you know that add value or enjoyment – trips away, Christmas, Birthdays, trips to the movies, hobbies etc. Then look at the expenses that you pay for now but are prepared to cut down on – eg daily visits to the café could become weekly ones.
Have a look at how your financial situation will change once you own your own home and include this in your budget. For example if you pay rent you won’t have to do that once you own your own home so you could use those payments to be put towards your home loan.
Some of our clients come to see us before they start saving their deposit and want guidance as to how much they should borrow and how much they should save. We recommend that they set up a savings programme that would be equivalent to the mortgage, rates and insurance payments on a new home. If they find that too tight then we suggest they decrease the amount until they find the weekly payment that they are most comfortable with and it is this figure that tells us what the home loan repayment should be. The home loan payment tells us what the loan amount will be and that will ultimately tell us what the purchase price that they should be looking at will be.
Don’t rely on others to tell you what you can afford. It’s important to know before entering in to any arrangement what the cost of that both financially and personally will be to you.
