Buying a new home, no matter whether it is your first or your fifteenth, is a big financial commitment. It often involves committing to repaying a large debt over a long period of time. The exact size of that debt depends on how much you borrow from the bank: this amount is ultimately limited to how much they believe you are capable of repaying and the unencumbered value of assets you already own.
The banks calculate your borrowing limit based on your household income, your expenses, your reason for buying the property, the size of your deposit, your credit history, and an analysis of the property itself. And many provide free online calculators to show you what that limit would likely be.
These tools are helpful because they enable you to limit your property search to homes you can realistically buy. But they can also encourage you to stretch your budget to an uncomfortable place, as banks and non-bank lenders have been known to offer you more money than you can afford to repay – although we have to say since the Banking Royal Commission thankfully Bank’s have taken far more care to ensure they follow responsible lending guidelines.
Even with Banks and all financial institutions taking far more care with their lending practices, you must ultimately take responsibility for your own financial affairs. So we have put together for you everything you should keep in mind when borrowing for you next (or first) property.
Every lender has slightly different lending criteria, although most follow a fairly similar process to determine how much they’re willing to lend you. They mainly keep five aspects in mind when assessing you borrowing power: income and expenses, credit history, deposit size, reason for buying, and property analysis.
Before deciding on a loan application, banks are legally obliged to take “reasonable steps to verify the consumer’s financial situation”. Since the Hayne Royal Commission, this has typically been understood to mean verifying a borrower’s income and expenditure by physically checking their bank statements.
Your income and expenses will form the backbone of your bank’s assessment of your creditworthiness, though they’ll show an interest in your employment status, too. Freelancers and contractors often deemed higher risk.
Some banks will assess only the person(s) buying the property, while others will perform a cursory assessment of every person who intends to reside in the property as their primary place of residence (within bounds, of course. They aren’t going to assess the income and expenses of your five-year-old). This is to ensure that if the property owner dies or is put into extreme financial stress, there will be another person(s) who will be able to continue to pay for the mortgage repayments, if necessary.
When a bank is assessing your financial position, the next aspect they’ll check is your credit history. The purpose of the bank assessing your financial health is to determine whether you’ll be able to service the monthly repayments, and a credit check goes straight to the heart of that matter, by telling banks whether you’ve paid bills on time in the past.
Deposit size is important in so far as it relates to the overall amount you will borrow compared to the value of the property you are buying. A larger deposit will result in a lower mortgage amount naturally. You may have heard of 5% and even $0 deposit property purchasers in the past. Sorry to disappoint but these are very very rare now. Most institutions are looking for a traditional 20% deposit upfront. Luckily our deposit can be bolstered by various federal and state government schemes — for example, the First Home Buyers Scheme.
Banks treat owner-occupiers and investors differently, with the latter generally charged higher rates. This reflects a perception amongst Banks that loans to investors are slightly more risky than those to owner occupiers.
Another major aspect of assessing your borrowing capacity is assessing what, exactly, you’re borrowing for. Banks will take a solid look at your dream home to determine how much it’s worth now, and how much it might be worth in 5, 10, 15, years from now. This is known as a property valuation, and is an integral part of applying for a home loan. Everything from the property’s condition and location to it’s floor plan layout and fit-out can affect their valuation of it. The bank’s final valuation will affect how much you’re able to borrow. For example if you are purchasing an apartment for $500,000, but the bank’s valuation only comes in at $475,000, then the bank will base all of their lending criteria on the valuation and not on the contract price. So if they said they will lend you 80%, that is 80% of the valuation not the contract price. Hence getting a good valuation is very important when it comes to borrowing money.
When it comes to working out what you can afford to borrow – as opposed to what a bank will lend you – there are two key rules to remember:
First, you should think twice about borrowing more than 80% of the property’s lender-assessed value if possible. This is because banks will consider you higher risk if you have a loan to value ratio (LVR) of over 80%, and may require you to pay for lenders mortgage insurance (LMI) as a result. Typically capitalised into your overall mortgage, this insurance enables banks to make a claim in the event that you default on your loan and the property sells for less than the value of the mortgage.
The exact amount of LMI you will need to pay depends on the size of your deposit, the size of the loan, and your reasons for buying, but it can often run into the tens of thousands.
For example, a homeowner hoping to buy a $500,000 property with a $80,000 deposit would likely need to pay $8,280 in LMI, based on a principal and interest loan with an interest rate of 3.69% and a loan term of 25 years. This can change with time though, so it’s worth running a few mortgage calculators to get a rough idea of what the current market interest rates are and how they will affect you.
With this in mind, borrowing more than 80% of the property’s lender-assessed value could result in you paying much more for your home over time than taking the time to save a larger deposit initially.
While ‘mortgage stress’ can look different for everyone due to the fact that no household is the same, the typical rule of thumb is that mortgage stress begins to creep in when monthly repayments exceed 30% of pre-tax income. When you move past that point, keeping on top of your repayments typically comes at the expense of your quality of life. You might be forced into buying cheaper groceries, socialising less with your friends, and giving up luxuries that you once deemed essential.
We often see first home buyers and experienced investors alike fail to keep in mind the additional costs of buying a new home or investment property. Some people get sucked into the excitement of buying and just look at the price tag the property comes with, failing to consider additional costs like conveyancing and legal fees, for example.
Before you go any further with your dream home, sit down and get a rough estimate for how much the following will cost you:
You might find that your state offers grants or concessions to fees like stamp duty under specific circumstances (ie. first home buyers, international investors, etc). Take you time to do adequate research on this to ensure that you’re not paying one cent more than you need to.
The interest rate and loan principal aren’t the only features worth checking out when you’re searching for the perfect home loan. Each offering will come with its own set of fees and charges, so it’s important to read through all the terms and conditions before deciding which loan is right for you (as tedious as that sounds). Here’s what you need to weigh up:
Most lenders will charge you a fee to set up your mortgage.
Each lender will charge you different ongoing fees to cover the cost of servicing your loan
Loans with lots of features, such as offset and redraw facilities, typically attract more fees and come with variable interest rates. And so, borrowers must weigh up the greater flexibility these features offer against their additional expenses. A more experienced buyer may find loans with this sort of flexibility more attractive than a first home buyer, because they have a greater understanding of how the market works and how to manage mortgage repayments.
Some lenders charge borrowers for making additional repayments, or place restrictions on the total amount of additional repayments a borrower can make. First home buyers and investors will want to keep an eye on this one, as these groups are the most likely to try to make additional repayments if possible.
Ultimately, how much you should borrow is dependent on your financial situation and personal goals. And while the information above will serve as a helpful guide, it’s no replacement for seeking professional advice. Seek out a financial advisor or mortgage broker for advice that is tailored to your specific circumstances. Give them as much information as they need so they can get as accurate a picture of your current finances as possible. Doing so will help you in the long run.