How Much Can I Borrow for a New Home?
If you're in the market for a new home or apartment, there will probably come a time when you need to figure out how much you need to borrow to secure your dream home. You'll need to ensure that you create your own budget prior to any loan approval to ensure the mortgage repayments you will be making each month for the years to come are manageable.
Borrowing the highest amount you can may get you your dream property, but the added costs of buying a house along with maintenance, repairs and possible interest rate rises can whittle the bank balance down quickly.
Here's a 2020 guide which will teach you about interest rates, equity, borrowing as an investor, and more.
1. Understanding interest rates
You will have two different rate choices when choosing a home loan, fixed or variable.
The fixed-rate option locks your rate in for a specific time period (often 1, 3 or 5 years) protecting you from potential rate rises. The flip-side is that if rates drop, you won't see the benefit of that. Many people are happy to forgo the gamble of possible rate drops for the security of knowing exactly what their repayments will be to make it easier for budgeting. It is essential to keep in mind that breaking your fixed-rate period early will incur a fee.
The variable rate is the exact opposite; the rate fluctuates with any changes the Reserve Bank of Australia (RBA) decides to make. This means your payments can both increase or decrease, which can either save you money or add to your costs. This option is essentially a gamble.
When viewing home loan offers, it is important to be aware of some terminology in reference to rates, including:
Standard variable rate: The rate your loan will revert to when the fixed-rate period ends
Comparison rate: All financial institutions are required to advertise this rate as it shows the real cost of your loan inclusive of fees built into the percentage
Split loan: One part of your loan may be at a fixed-rate, the other variable
Assessment rate: The rate used to assess the serviceability of your loan which is often slightly higher than whatever your actual rate will be to provide a buffer
2. How much can I borrow?
Ultimately your income and expenses determine your borrowing amount, but you will need to take into account any future financial goals and the hidden costs associated with buying a home.
You'll want to account for:
Necessary renovations and repairs on the new property
Current debts, credit cards, and personal loans
Living expenses
A savings buffer in case you run into trouble
Once you decide on a reasonable limit, stick to it, regardless if you are offered more to avoid overcommitting. There are three factors to what you can safely borrow:
The size of your deposit
The amount you make
Your expenses
Today in Australia, mainly thanks to the Royal Banking Commission, lenders are stringent and will look at a variety of factors before determining your pre-approval figure. To get a ballpark figure, a recommendation is to multiply your savings by 10. If you had $40,000 deposit, you could safely afford a $400,000 property.
3. Equity in your home
If you already have a property and are looking at purchasing another, you can use 80% of the equity in your asset. You will, however, need to account for a possible reduction in this figure based on your income and overall capacity to pay back the loan.
To determine the exact amount you have to play with when it comes to equity, you'll need a property valuation. The amount will come down to 80% of what your property is valued minus what you owe on your mortgage.
If you are looking at making the second property an investment, you'll need to consider a few other points as well.
4. What sort of home can I afford?
The money you earn increases your borrowing power. Your income, living expenses, debt, and the size of your deposit all play a role. If you make $50,000 a year and spend around $600 on living expenses, you may land in the $250,000 and $310,000 range, depending on the lender.
Those in the lower brackets may wish to consider an off-the-plan apartment which lowers the price based on the fact you won't actually physically see the property until it is built. This can often be a great way to get a foot in the door in the world of property ownership.
5. How are my living expenses calculated?
The Household Expenditure Measure (HEM) is a guide that lenders will use to determine a person or couple's average yearly expenses. They will often be quite generous, and often a little unrealistic when it comes to expenses to ensure you have room to move.
If you are borrowing against the equity will help raise your borrowing amount, or you could look at having a guarantor. A guarantor helps secure your loan and is legally responsible for the loan if the borrower can no longer handle the debt.
6. Borrowing as an investor
Investment properties often require a larger deposit but also take into account any income that the investment property can generate as well as added costs of ownership. The main costs will include:
Loan repayments
Council rates
Maintenance
Property manager's fees
Vacancy periods
One advantage to the investment property scenario is negative gearing, which can offer a tax break based on the deficit caused by the cost of owning a property if it outweighs the income the investment is earning.
It is crucial to keep in mind that a negative profit on an investment provides tax advantages but is still an element that is costing you money. For example, if the overall costs for your investment are $2000 per week, and you receive $1750 in rent per week, you will receive a tax deduction of $250. The catch is that the $250 is coming out of your pocket.
For this reason, negative gearing is suitable for high-income earners purely for the tax benefits. When looking at investing, your risk profile needs to be considered carefully.
7. Borrowing for your new home
When you begin down the road of securing finance for a new property, keeping a sensible, realistic, and affordable mindset is the most important thing to do.
Not overcommitting to a hefty financial burden is all you really need to worry about. Remember, you will have this loan for many years, and while it seems possible to stretch yourself a little thin now for a nicer place, this may not always be so easy. Sometimes you will need to sacrifice the home or location of your dreams to ensure you can still live a comfortable lifestyle.
There are plenty of facets to consider when buying property, doing your research, and making smart decisions will save you many headaches or a potential disaster down the track. Always have a buffer, and your foray into property ownership should be a smooth ride.