Can You, Or Should You, Borrow?
Before you apply for a home loan, there are a number of things you need to consider.
For one thing, having the borrowing capacity for the loan amount you are applying for is important.But if a bank tells you that you can borrow $500,000, does this mean that you should?
The banks can calculate your borrowing capacity, but only you can work out how much you should borrow. This is because:
- Borrowing to your limit can put you at risk if interest rates increase.
- You may want to maintain an especially high standard of living
- The bank doesn’t know your future plans; for example, starting a family
The Mortgage Costs You Didn’t Know Existed
While most people factor in their regular expenses and income when making a borrowing decision, many fail to look at the costs that come with taking out a home loan.
Setting up a home loan can be quite expensive and there are many costs related to the purchase.
Associated Ongoing Costs
There are many costs of owning a home. Just like home loan repayments, these will be ongoing and may even increase. These costs can include ongoing maintenance and repair costs, insurance, and council and water rates.
Whilst these may not seem large, they do add up.
It is important to determine if your income will cover these costs, so that you can avoid falling behind with your repayments.
A rough guide is that your home loan repayments and associated costs, taken together, should not exceed half of your gross income.
Other Expenses Associated With Buying A Home
There are also a number of one-off or infrequent costs associated with property purchase that need to be taken into account.
- Loan application fees.
- Inspection fees such as building and pest inspection.
- Government fees such as stamp duty and land transfer fees.
- Legal / conveyancing fees.
- Removalist charges.
- Lenders Mortgage Insurance (LMI).
What Will The Lenders Take Into Account?
Your income is the most important factor that determines your borrowing power.
Every lender has different requirements; however, most banks will also look closely at your current financial commitments and debts when calculating how much you can borrow.
If you have credit cards, personal loans or HECS debt, this might affect your ability to manage your home loan repayments.
It is essential to make sure that your income will cover all of your current financial commitments and the new proposed loan.
Boost Your Savings And Start Budgeting
There are many things that you can do to boost your savings. The first thing you should do is set up a budget.
This will show you how much of your money you are spending and where to make changes.
Another good idea is to set up automatic payments into a high-interest savings account.
Type of Loan And Interest Rate Affect Your Borrowing Power
The type of loan you choose and the current interest rates affect how much you can borrow.Today, most lenders add at least 3 percentage points on top of their standard variable interest rate when calculating your ability to repay the loan. This is known as an assessment rate.
For example, if you want to borrow $500,000 and the current interest rate is 7%, a lender will add the 3 percentage points loading, and will assess your ability to repay the loan if the interest rate were to increase to 10%.
Some banks will reduce their assessment rate by the discount on their professional package. If your mortgage broker can negotiate a larger discount, then this will increase the amount that you can borrow.
Inclusion Of A Buffer
Many lenders will approve your mortgage application if you can afford your repayments at the assessment rate and have just enough money left over to pay your current debts and living expenses. In other words, even if you have no spare funds left after meeting your commitments.
Other lenders will require you to have spare funds left over after paying your debts. This is known as a buffer.
The lenders include this buffer because they want to know that if your situation changes you can still afford the debt and any significant interest rate rises.
If your bank uses a buffer then it will greatly reduce how much you can borrow for a house.
Is Fixing Your Interest Rate A Good Move?
Fixing your interest rate can help considerably.
Using our example above, when you are applying for a variable-interest home loan, the lenders are assessing you at 10%.
However, if your interest rate is fixed at 6% for three years, then some lenders will assess your repayments at the three-year fixed interest rate, instead of their assessment rate.
This can make a huge difference, allowing you to borrow much more.
You will need to consider that when the fixed rate expires your loan will revert to the variable rate. So you might choose this option if you expect your income to increase before the end of the fixed-rate period.
If you think that serviceability may be an issue, please enquire online or call us on 1300 889 743. We can determine the best home loan for your situation.
Frequently Asked Questions (FAQs)
Do I Have To Pay LMI?
By having a deposit that is 20% of the property value, you can avoid Lenders Mortgage Insurance (LMI).
If you are borrowing more than 80% of the property value, you will have to pay an LMI premium.
This can be quite a large cost that you will be required to pay on top of all the other costs associated with your home loan. The advantage of paying LMI is that you may qualify for a home loan with as little as a 5% deposit.
Why Should I Reduce My Risk?
Make sure that your finances can cover any expenses that may arise if your circumstances change. These can include events such as interest rate rises, starting a family, illness or unemployment.
By setting up an emergency fund and continually making deposits into it, you will have a buffer to cover any unexpected costs that come up.
You may also consider taking out income protection insurance, life insurance and trauma insurance, which can reduce your risk further.
What If My Interest Rate Rises?
It is essential to assess the impact that an interest rate rise will have on your loan. Ask yourself whether you would realistically be able to afford your repayments on your current income if the RBA increased interest rates.
You should be able to afford a rate rise of up to 2 percentage points, so a good tip is to add this amount to your current interest rate and calculate whether you would be able to make these repayments.
If you can cover the rise, then you will avoid falling behind with your mortgage.
Know What You Can Afford
When searching for a new home, it is a good idea to get a pre-approval on your loan. Whilst online calculators are great, the only true way to find out how much you can borrow is to get a pre-approval before you start home hunting.
This will save a lot of time and stress in the long run.
To find out more about getting a pre-approval for your home loan, please call us on 1300 889 743 or enquire online for free today!