Buying a home is a major decision-committing to repaying a huge mortgage over a long period of time is also involved.
The precise amount of this debt depends on how much the bank borrows. And that amount, in the end, is limited to how much they believe you can repay.
These tools are useful because they allow you to restrict your search for properties to homes that you can realistically purchase. But they can also inspire you to extend your budget to an uncomfortable spot, as businesses typically offer you more money than you can afford to pay back.
Using our helpful home loan calculator to help you figure out the average balance of your loan, monthly repayments and borrowing costs.
What affects your borrowing power?
Although each lender might have very different conditions for lending, most will adopt a reasonably similar procedure to decide how much they are willing to lend you.
1. Your household income and expense
Banks are legally obligated to take “reasonable steps to check the financial condition of the borrower” before deciding on a loan application. This has typically been understood since the Hayne Royal Commission to mean verifying the revenue and expenditure of a borrower through physical checking of their bank statements.
Your income and expense will be the backbone of your bank’s creditworthiness evaluation, while they will show an interest in your job status;
Freelancers and contractors have often to be at a greater risk.
2. Your credit history
This one is, truly, a no-brainer. The intent of the bank evaluating your financial condition is to determine if you will be able to serve the monthly repayments, and a credit check goes directly to the core of the matter, telling banks if you have paid bills on time in the past.
3. The size of your deposit
Most lenders will give loans to borrowers with deposits as low as 5% of the lender-assessed value of the house, but additional fees will be charged for those with less than 20%. More on the later.
4. Your reason why you purchased the property
Banks handle owner-occupants and creditors differently, with higher rates generally paid to the latter.
5. Property analysis
While evaluating your personal finances, lenders are going to take a closer look at the property to decide how much they are willing to lend you.
Anything from the quality and position of the property to its floor plan and fit-out will affect its value and its value will affect how much you are able to borrow.
How to calculate with what you can afford
There are two key rules to remember when it comes to working out what you can afford to borrow – in contrast to what they can lend you.
It’s better to borrow not more than 80% of the value of the property.
Lenders will find you high risk if you have a loan-to-value ratio (LVR) of more than 80%, and as a result you will need to pay for mortgage insurance (LMI) from lenders.
The exact amount of LMI that you’re going to have to pay depends on the amount of your deposit, the size of the loan, and your purchasing purposes, but it can always run into tens of thousands.
As per our mortgage calculator, a homeowner wishing to buy a $500,000 property with a $80,000 deposit would probably have to pay $8,280 in LMI, which based its calculations on a principal and interest loan with an interest rate of 3.69 per cent and a loan term of 25 years.
And so, borrowing more than 80% of the lender-assessed value of the property could cause you to pay much more for your home than spending the effort to save a larger deposit.
Keep your monthly repayment below 30% of your net income.
There is no common definition of mortgage strain, but most experts think it starts creeping in when your monthly repayments reach 30 per cent of your pre-tax income.
When you step beyond that point , usually keeping up your repayments comes at the cost of your quality of life. You may be forced to buy cheaper food, socialize less with your friends, and give up luxuries you once considered essential.
So make sure you calculate your monthly repayments with our free mortgage calculator before you set your mind on buying a specific home. To know more, click here.