When it comes to mortgages, size really does matter. Haley North reveals practical tips to ensure you stay within your safe borrowing limit.
Having a good understanding of your borrowing capacity can prevent you wasting lots of time looking at properties that are well above or below your price bracket.

There are many resources online that you can use to help you determine roughly how much you can borrow. However, it’s important to remember that these online tools are generic and do not detail the different policies and approaches each lender may offer you in your particular circumstances. As part of your home loan application process, your lender will take a number of specific factors into account when assessing your borrowing capacity.

Some of these factors will be your income, current liabilities (including credit card limits or store cards), the number of dependants you have, any ongoing rental commitments and whether you are single or have a partner.

The assessment process of each lender will differ. For example, one lender may allow a higher lending amount for a single person with no dependants and another may include the extra money you earn by doing overtime in your income.

Doing your sums
Although a lender will use a specific set of criteria to determine a safe borrowing limit for your home loan, it’s important that you cross-check this figure with your own budget to ensure you stay within comfortable levels.

You should never base your decision on the figure that someone else tells you that you can afford. Some lenders may offer you a higher loan amount than you can comfortably and realistically afford based on your income. It’s very important that you complete a detailed forward budget to ensure you are comfortable with the repayments over the life of the loan. You should also build into your budget a small financial buffer for unforeseen circumstances and changes in lifestyle. The Your Mortgage website www.yourmortgage.com.au provides a handy Income and expenditure calculator to help you crunch the numbers and get a rough idea how much you can borrow.

Drawing up your budget
A financial planner can assist you in preparing your budget but this can be costly. By looking at your income and all outgoings, you should be able to calculate your budget accurately. However, a good broker could work through this with you if you feel you need some assistance with it.

To give you a broad and simple picture, your comfortable loan repayment might be roughly the amount you are paying in rent now plus some of your savings (if the property will be owner-occupied). This is only a rough guide as you would still need to take into account other expenses such as rates.

You will need to double check the figures you come up with in your planning budget. Remember that the figures in your budget will show you your current capacity rather than what you ideally feel you should be able to afford.

If your needed mortgage repayment differs from what you are currently paying in rent and saving, and you feel you are able to save more money, implement a stricter budget as soon as possible. This way, you’ll quickly know whether it works and you’ll be practising your new lifestyle before your mortgage repayments begin.

If you find you are in the category of applicants who feel comfortable with a higher loan repayment than it seems possible to borrow, talk to your mortgage advisor (broker) to explore your options.

If you are in this category and want to be able to pay a higher purchase price, there are strategies you can use, such as how you structure your mortgage, to get the loan amount you require. For example, some lenders will let you have a servicing guarantee or lend you higher amounts if you take a particular type of repayment or loan.

Costs and expenses to factor in
The most important thing about determining your borrowing capacity is knowing that you can maintain the month-to-month expenses for the long term.

When working out your budget, keep in mind what your future expenses will be once you have purchased a property so that you don’t find yourself out of your comfort zone at a later date.

As a homeowner, you will have to factor in the following costs (although this is by no means an exhaustive list):

  • council rates
  • body corporate fees
  • insurance costs
  • maintenance costs
  • utility bills
  • management costs (if you are buying an investment property)
It is also important to take into account what changes you may be expecting in your circumstances in the coming years and how these may affect your financial comfort with your repayments. You need to ask yourself the following questions:
  • Do I expect my income to increase in the coming years? (For example, you may have recently obtained qualifications that will boost your income)
  • Do I plan to have children and cut back on my work commitments?
  • Do I plan to retire in the short term?

Taking your expectations for the future into account may either give you greater comfort with your projected repayments or result in deciding to limit what you are willing to borrow. You don’t want to limit yourself unreasonably by borrowing less than you can comfortably afford and not getting the best property that you can. But there is no advantage in stretching yourself so far that it becomes unmanageable.

Boosting your borrowing capacity
If you are going to rent out the property the lender may also take into account the expected rental return and any applicable negative gearing benefits when determining your borrowing capacity.

In order for the lender take the projected rent into account, you will be required to provide a rental letter from a real estate agent outlining the expected market rental return. If the property is already leased, you may be required to provide evidence of tenancy to the lender. Some lenders may use the rental return estimated by the valuer over a rental letter so it’s important to know that not every lender looks at this in the same way.

When buying a property for investment purposes or one that may become an investment property in the future, make sure you get advice from a trusted accountant to work out the possible tax benefits and on what you need to do to prepare yourself for the future.

Your broker should also be able to assist you in determining other ways you can increase your borrowing power. One way of doing this is by lowering your other liabilities. For example, if you have a high credit card limit but you’re not using it each month you could have the limit lowered. Credit card limits affect your borrowing power. Lenders take the full credit card limit into account for servicing because there’s the potential for you to spend that amount – even if there is no debt on the card.

Your broker may be able to request that the lender doesn’t include the limits for servicing by providing evidence that the cards are always paid in full each month. If this is not possible, you may consider closing the cards and switching to a debit card facility.

If you are looking to increase your borrowing capacity, it may also be advantageous to consider paying out any other liabilities, such as personal loans or car leases.

It’s important to carefully weigh this up in case it impacts you in other ways. For example, if you were to use some of your deposit to pay out your personal debts, or if you wish to incorporate your debts into your home loan, this may push your loan to value ratio (LVR) to over 80%. If so, you will need to pay lenders mortgage insurance.

In this case, the cost would need to be weighed up against any potential interest savings and the benefit of being able to buy a more expensive property (because your borrowing capacity will be increased).

When personal debts are refinanced into residential lending, the repayments on the same debt balance will decrease due to the usually lower rate as well as the longer loan term. It’s important to remember to continue to reduce the net debt balance as quickly as possible so that you don’t end up paying more than you have to.

Staying in control 
Even if you’ve created a fool-proof budget plan for the long term, there may be things outside of your control that will put pressure on your finances and impact your ability to meet repayments.

Unforeseen illness or injury can often be the cause of financial hardship, so it’s important to consider protecting yourself and your family with the appropriate insurance. This may include income insurance, life insurance, or total disability and recovery insurance. I’ve often heard people say this is only necessary for people with children but it’s important for everyone to consider.

If you’re single, you wouldn’t want to have to sell your beloved property if sickness or injury prevented you from meeting your loan repayments, especially when you could have easily planned for such an event.

If you were in a relationship and your partner fell ill, the entire loan repayment would have to be serviced by your income alone. If you were lucky, you’d be able to take on extra work commitments to compensate for the loss of the second income. However, you’re likely to have to reduce your work hours in order to care for your partner.

Many people think ‘it won’t happen to me’, but you never know what life will throw at you. With a little advice from a trusted planner or insurance broker, you can ensure you have planned for the bad times as well as the good and feel safe, knowing that you have protected your investment.

In short, the most important point to consider when taking on new lending is that you need to be financially comfortable with your monthly repayments. Purchasing a property requires careful planning. By taking responsibility for your borrowing through planning and budgeting, you prepare for the best outcome for yourself.

Case Study: Out of the rental market and into his first home
When the planets aligned to produce ideal buying conditions, first homebuyer Richard Kefford jumped at an opportunity that was too good to miss out on.

First homebuyer Richard Kefford had been renting in Camperdown in Sydney’s inner west since he returned to Australia from London in late 2007.

Due to high rent ($1,200 a month) and living expenses, he was unable to save for a deposit to buy a home.

That was until earlier this year when the opportunity presented itself. The combination of a work promotion, falling interest rates and the increased First Home Owner Grant offered Richard a prospect too good to refuse.

“Suddenly, I was looking at a different set of circumstances than I had been looking at during 2008,” Richard says.

“I started thinking about the possibility of getting a mortgage and within a few days I had contacted a mortgage broker for advice.”

Richard found mortgage broker Ian Jordan of Mortgage Selector through his work colleagues and decided to use his services.

“I chose to use a broker because finding the right home loan was the hardest process of buying a home,” he says.

After determining Richard’s borrowing capacity, Ian proceeded to arrange pre-approval for a Citibank standard variable home loan on a 30-year term with an interest rate of 5.99%.

House hunting
After the pre-approval came through, Richard began searching for a property around Sydney.

“After renting in Camperdown for some time, I decided I really wanted to stay in the suburb. It’s close to the city and areas such as Leichhardt and Glebe, where I like to spend a lot of my time,” Richard says.

“I knew the area well, which is a key factor in looking for any property, I believe.”

After some research, Richard discovered Frasers Trio Apartment development in Camperdown and was immediately impressed by their off-the-plan designs.

“I was comforted by the fact that Frasers have a great reputation for producing good quality developments,” he says.

Not long after seeing the plans, Richard paid a 5% deposit on a $460,000 one-bedroom unit.

Although Richard says he would have liked to have been able to save a larger deposit, he is content with being able to maintain his lifestyle while buying the home.

“Although I could only handle a 5% deposit, I haven’t had to sacrifice any of my social life to buy the unit and I didn’t want to either,” he says.

By buying into the market before 30 June 2009 Richard has made a saving of over $40,000.

As a first homebuyer in NSW purchasing a new dwelling, he received $24,000 for the First Home Owner Grant and saved $16,000 in stamp duty.

Cheaper to buy or rent?
Although it’s cheaper for Richard to continue renting than buy a place of his own, he says there’s no point sending your money into the rental abyss.

“I find it much easier to justify spending $2,400 a month on mortgage repayments over $1,200 a month renting,” he says.

“This is especially so when the money is going towards building the equity in my property rather than disappearing into someone else’s pocket.”

Richard says although his monthly position will be fairly tight, he has created a strict budget and will follow it diligently.

“If rates continue to fall, this will ease the pressure a bit more,” Richard says.

He says he plans to leave his mortgage as a variable rate for the next six to 12 months in order to get the most benefit out of the low interest rate environment.

“I don’t think interest rates will increase too soon, and as soon as I get a feeling that they might be going up I will look around for a good fixed rate deal,” Richard adds..

Advice for others
He advises other intending first homebuyers who are currently renting to conduct an honest assessment of their financial position by comparing their incomings with their outgoings.

If your borrowing capacity allows you to buy a property, he says, you should go for it.

“Look at how much you can spare each month and then go and speak to a financial expert and a mortgage broker and get some advice,” Richard says.

“If you’re renting and wondering what things would be like as a home owner, there’s only one way to find out. Life is too short to wonder; life is too short to rent.”

Richard's Details
Property: One-bed unit in Camperdown
Purchase price: $460,000
Interest rate: 5.99%
Lender: Citibank
Product: Variable
Deposit: 5%
Loan term: 30 years

Haley North is a mortgage advisor for Smartmove, a boutique firm based in Neutral Bay, Sydney. If you would like a detailed budget planner, want more information or have any questions, contact haley@esmartmove.com.au