You know how it goes. You set eyes on a dream home, you can visualise what it would be like to live there: have friends round to dinner, play with the children in the backyard or enjoy the view from the terrace, glass in hand, on a balmy summer's evening.
Whatever it is that makes the property click for you, you'll be tempted to do anything to own it and live your dream. Odds are that this will stretch you financially (such is the nature of dreams). The first step is to get someone to lend you the money.
What's your limit?
All respectable lenders have criteria they work with that allow them to assess each case on an individual basis. They'll lend you the money to buy a property based on your ability to meet repayments. This will take into account incomings, outgoings and other details such as number of dependants.
It's difficult to give a general assessment of exactly how much you'll get from lenders because each one will come up with a different amount, depending on whether you have a deposit, what sort of interest rate or loan you are taking out, and your age.
Lenders generally have their own criteria when it comes to deciding how much to lend, but there are always a few rules of thumb that apply across the board.
Dean Mathieson, director, Professional Mortgages Providers (PMP), gave his top five lending considerations.
1. The reference rate is always above our standard rates to ensure the client has a buffer.*
2. What assets and liabilities does the client have?
3. How many adults living in the house?
4. The number of dependent children.
5. A serviceability calculation which accounts for rate rises and the client's ability to service the debt comfortably.*
* The calculators are priced at usually 2% or more above the current rate on our products to ensure that clients have sufficient disposable income in case of rate rises or other changes to their financial situation, which may affect the amount of income they have available for the repayment of our loans. The PMP Basic product is 7.18%, but the reference rate is 9.55% and this is what the repayments are calculated on.
Some commentators believe that lenders should take more responsibility for the amounts of money lent and be more realistic in assessing affordability.
This is a claim denied by Mathieson, who believes PMP already does everything it can to safeguard against people overstretching themselves. "We can only go by what the clients have disclosed in the application and our CRAA (credit reference) as to whether other debts exist and therefore the client's ability to service the debt. Our serviceability calculations take into account many things and also require a buffer in terms of servicing any new loan with PMP."
Taking control of your finances
It's one thing getting access to a loan to buy that dream home - but another to be able to afford the repayments. One of the biggest things to remember is not to take a broker's estimation of affordability too seriously.
John Whitley, of 5 Minute Money Manager, has developed software to help people track their spending and understand where their money is going.
"Most lenders don't allow enough for day-to-day living when assessing affordability. They usually leave around $12,000-13,000 pa for day-to-day expenses after loan payments. Most people aren't that frugal; they have a certain lifestyle and enjoy living life to the max."
Whitley says the most important thing is to understand exactly what's happening to your money on a daily basis, before you can decide whether you can afford the repayments on a big loan.
"It's imperative for people to understand where their money is going and what they spend money on off the cuff. It could be Mars Bars, coffee or magazines, but it is likely to add up to a significant amount. It allows you to either change your budget or change your spending."
Armed with this sort of knowledge, you can seriously estimate whether you can afford your dream house with your current lifestyle, or if you will need to make sacrifices to achieve it. All these are decisions that must be made before putting pen to paper and signing on the dotted line of a lender's contract.
Accounting for future expenses
It's one thing to correctly understand how much you can afford to spend at the time of taking the mortgage, but another to know what your expenses will be when you're still paying the loan off at the same rate, in 20 years' time.
You may think it's a stupid question that can never really be answered, but it pays to think carefully whether a change in future circumstances could materially affect your income or expenditure and make it impossible to afford a loan that is affordable now.
Most young people assume their capacity to service debt will increase with age, but that isn't always the case. Having children is one classic example of a huge increase in expenditure that has to be budgeted for.
Deborah Southon, director at Fox Simon Associates, believes this is very important: "Anybody borrowing for a house must ask themselves if it is affordable. They must ask if their future employment is stable, and if they work on a commission or bonus basis whether they can factor that in. "If you're planning on having children, will one partner give up work, or will there be childcare costs that affect the capacity to service a loan?
"Southon also reminds the buyer that there are many costs you don't have as a renter which materialise when you buy a house. These include building insurance, rates and maintenance costs.
"I would recommend that people pay no more than 33% of their current income out in mortgage repayments.
"If someone can get a mortgage for $1m, they should consider reducing that to $750,000 for example, so they have funds to allocate towards maintaining their lifestyle.
"I have seen people who have allocated as much as 75% of their income to mortgage repayments. It's so difficult to be able to live like that - before you have bought any food, or turned on a light switch, most of your money is gone.
"That compromises your entire lifestyle and is no way to live."
10 Things to consider before signing up for a home loan
1. Is your industry stable?
2. Is your job stable/how easy is it to find similarly paid employment?
3. What percentage of your income will be spent on the loan?
4. Are you factoring bonuses and commission into the equation?
5. Will you have children?
6. If you have a joint income, is your partner likely to take time off to look after children?
7. Have you factored in the cost of rates, insurance and maintenance?
8. Will you send your children to private school/university?
9. How important is your current lifestyle to you?
10. Could you change your lifestyle in order to repay a big mortgage?
Source: Deborah Southon, Fox Simon Associates
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