If you’re thinking about taking out a new home loan remember this: there’s a big difference between what the banks say you can borrow and how much you should.
The common definition of ”mortgage stress” is this: if you spend more than 30 per cent of your pre-tax income on your home loan repayments, then you are officially in the danger zone. That ratio looks pretty outdated when you look at the numbers from the recent ABS census, which show that three in 10 mortgagees meet this definition.
Data source: homeloanexperts.com.au
In fact, a quick tour of the major banks’ online calculators by Smart Investor Money suggests they are happy to burden you with a mortgage that would lead you to handing up to 45 per cent of your gross income – and closer to 60 per cent of your take-home pay – on repayments (take a look at our shadow shopping exercise in ”How much the banks will lend you” above.)
What you need to understand is that the banks’ calculators use a ”dollar-plus” model of assessing your capacity to repay. As long as you have a dollar left over after taking into account the proposed repayments (including an interest rate buffer of a percentage point or two) other debt obligations and living costs, the loan is – theoretically – yours.
It’s easy to see that the big unknown here is the level of expenses. Some calculators ask for your estimated monthly expenses. But all use a back-up measure of how much you need to pay them back and just scrape by, based on something called the Henderson Poverty Index and, more recently, the Household Expenditure Measurement.
If you are at this line you are essentially in baked-beans-for-dinner territory.
”You don’t want to go anywhere near that,” says the research and insights director at mozo.com.au, Andrew Duncanson. ”That means you can pay it back, but it probably means it’s going to be uncomfortable.”
DISCOVER YOUR LIMITS
”My argument has always been that people aren’t very good assessors of their ability to pay,” says the principal solicitor at the Consumer Credit Legal Centre of NSW, Katherine Lane. ”They just go into the bank and ask for what they can get, and then work out what house fits that price,” she says.
That puts the cart before the horse, and is exactly the wrong thing to do. The right way to approach a home loan is to do a thorough budget. Once you have a good handle on what is coming in and going out – and where – then you can make a proper assessment of how much you can afford to repay, and therefore the size of the loan.
”I would encourage people to use an independent calculator, such as the ones at moneysmart.gov.au, rather than the calculators on the banks’ websites,” says the director of policy and campaigns at Consumer Action Law Centre in Melbourne, Gerard Brody.
Building a buffer into your budget is crucial. Take our young couple above. They are probably planning on starting a family in the coming years – could they do so while being close to what is considered the poverty line for a childless couple? What if one lost their job or got sick? Or if interest rates doubled?
”Definitely try to be realistic about what you’re buying to meet you and your family’s needs without having to get too big a loan,” Lane says. ”Be realistic about having children, studying, or changing jobs.
”If all that fails and you really need the house and you need to borrow the maximum, do that but be absolutely motivated to bring the housing loan down as quickly as possible. Nobody in Australia knows whether they are going to have a job or not in the future. It can happen to anyone.”
Mortgage overload: what the banks will actually lend you
A young couple want to break into the property market. They head online to get an idea of how much they can afford to borrow. The Commonwealth and Westpac tools are straightforward. They put in their annual gross incomes – $60,000 and $40,000 – with no extra income or debts and $10,000 in combined credit card limits. Press of a button and – bingo – they discover they could borrow $478,000 with Westpac and $539,000 with CBA over 25 years and at rates of 6.89 per cent and 6.8 per cent, respectively.
ANZ and NAB’s tools are slightly more sophisticated: they ask for a general monthly expenses figure. Put in $2800 and our young couple discover they can borrow $502,000 from ANZ and $481,000 from NAB. In the same ballpark as the previous two.
All those numbers are high. But it’s when you look at the monthly repayments that the load becomes clear. The monthly obligations range from $3340 to $3740. After compulsory minimum super and income tax, the couple bring home about $6400 a month. On those amounts they would be committing from a bit more than half to almost three-fifths of their disposable income on meeting their repayments. If you factor back in the $2800 for monthly general expenses, that leaves a slender buffer of a few hundred dollars between them and struggle town.
Story by Patrick Commins, story source: www.domain.com.au