How much should you spend on your first house in 2020?
2021 UPDATE: It is important to know that the way banks and financial organisations assess their loan criteria has significantly changed in recent years. Banks are fighting back against the Royal Banking Commission who cracked down on lending criteria. This means that the terms of acquiring a loan are more stringent than they were a few years ago.
There is a simple rule that people can often forget; just because you can spend it, doesn't mean that you should. This is particularly pertinent when it comes to how much should you spend on your first house. The loan amount you are approved for doesn't always align with a realistic financial responsibility, which is why you need to determine how much you can afford for yourself first.
Figuring out how much you can afford to pay each month goes much further than just the sale price, as there are many hidden costs associated with buying a home. Your lender may surprise you with an approval of more than you were expecting, and while this makes it tempting to upgrade, it may not exactly fit your budget.
To help, Urban.com.au has put together this guide to help determine how much should you spend on your first house vs. income so that you can be well-prepared to live a comfortable life in your new home. The answer is different for everyone as situations vary, the key is to leave yourself a decent buffer so you don’t end up in hot water.
Responsible lending
It is important to know that the way banks and financial organisations assess their loan criteria has changed significantly since the Royal Banking Commission, which has cracked down on lending practices. This means that the terms of acquiring a loan are a little more stringent than they were a few years ago as financial institutions need to be more stringent to ensure responsible lending.
Make no mistake about it, predatory lending and loose underwriting standards for residential loans are a bad thing. Sure, more people are approved for mortgages, but they are mostly unrealistic when it comes to monthly payments which cause a lot more damage for the individuals and the property market as a whole in the long run. When it comes to buying your first home, and if you are looking at adding to your portfolio, defaulting on a mortgage is the worst case scenario, and it is solely up to you to ensure that doesn’t happen.
People have in their lenders, surely if the bank said it was ok for them to have an amount they can afford it, right? Wrong. This exemplifies the importance of running your own budget and knowing what you can afford. Mortgage lenders are not always offering sound financial advice. It is a bank's business to create and sell loans. Some lenders may even have incentives to sell loans meaning your best interests are not the primary goal.
Understanding the whole picture
The key to understanding how much you should spend on your first house is not just about deciding what you can afford now. It would be best if you also projected what you could afford in the future, aiming for the next five to 1ten years. While it can be hard to do this, as life can be unpredictable, your best-guess predictions will have to do and serve you far better than only looking at your current state.
Lenders are often calculating your affordability based on the information you provide, which is often lacking the intricacies of your true financial picture, or how it may change. You may experience changes to job roles and income, have children, or a range of other situations that will require you to have some sort of financial buffer. Keep in mind that bailing out and selling your home isn't always a failsafe plan if things get complicated. The property market is very unpredictable at the moment, and there are costs associated with selling your home.
Keep in mind that lenders look at your situation with a forecast that everything will travel smoothly with little fluctuation, it is on you to be realistic and skeptical, planning for the unexpected and keeping a level of financial security at all times. If you plan for the worst, you will experience positive little bonuses along the way if it doesn’t happen.
Income doesn't always go up
One thing that banks and lenders assume is that your income will grow as time passes. While everyone hopes they will be making more money in the future, it simply is not always the case.
The rule of spending 30% of your income on your home expenses is now often defined as a ‘mortgage stress’, for those that are new to the workforce. The current cost of living, especially for those who may be first home buyers new to the market, means that 30% probably won't actually cover all home expenses.
For this reason, banks lend more than the 30 per cent benchmark based on the assumption that the earning power will go up in the future. But what if it doesn't? Homeowners may need to redefine their approach to homebuying. It's widely noted that rising house prices are spreading beyond Sydney and Melbourne as house prices spread beyond, even despite the decline of pace in development growth.
The only rule left to stick to is to purchase a home that you can afford and buy realistically from the jump. Your property may not go up in value, and your income may plateau or drop.
Focus on the repayments
Loan terms can be tweaked so that lower payments are required at the beginning of a loan to make the amount more manageable. This is another reason why you need to plan for the long term. Low-interest rate short-term mortgages with variable rates seem like a great deal with a manageable financial outlay to start with, but you are committing to a 30-year debt. Even a fixed-rate mortgage, which will give you a more accurate picture, can only be locked in for around five to ten years.
You may be flush with funds as you have your deposit saved up, plus the first home buyer grant is making things seem even better, but thirty years is a long time, and things will change.
A large percentage of your income will go towards your new home, and other areas of your life will need to become more cost-effective as a result. This may even affect your retirement and quality of life. Financial stress can also put a strain on relationships and mental health. Only you can determine an affordable mortgage that is conducive to a lifestyle that will make you happy.
To achieve this, understand your monthly budget, the interest rate, and taxes. You will likely benefit from speaking to a financial planner to really understand how much you should spend on your first home, as they will look at your whole financial situation. Research the true cost of living in the area you plan to buy.
Deciding what you should spend on your first house
If you are at the point where you are ready to start looking for your first home, work out a budget before you start shopping. Budget for:
Home insurance
Taxes
Housing repairs
Stamp Duty
Utilities
Council Rates
Lenders fees
You do not want things to be tight when it comes to your house payment. Your budget will need to cover living costs as well, so sometimes it's a good idea to practice living on your new budget before you buy your home to see if it is realistic. The money you would be spending on the "mortgage element" during this trial can be put into a savings account for your new home.
If you find yourself in the position where the style of home you wanted doesn't align with what you can really afford, you may need to wait a little longer to increase your deposit. You'll have to decide if putting off buying a home for a few years is worth it for the home of your dreams, or if you can sacrifice size and location to get into the property market sooner? Being financially ready to purchase a home is the most important thing.
If possible, have your loan pre-approved before you begin shopping for a home. It would also be best to have a buffer or emergency fund in place in case the worst happens, and you lose your income source. Keep in mind, the requirement of a loan payment doesn't stop because your situation changes. As long as you are realistic and err on the side of caution, things should be just fine, and you can start your property ownership journey with peace of mind.