Before you even start looking to buy a home, one of the most important factors to assess is how much you can comfortably afford in mortgage repayments.

You may be surprised to know the lending industry has its own measure of how much of your income should be dedicated to your mortgage repayments, and it may not always coincide with your own.

Let's dive into the figures.

What percentage of income should your mortgage be?

The lending and property industries are traditionally said to consider 28% of a person's pre-tax income to be an optimum figure for mortgage affordability.

Yet a person spending more than 30% of their income on home loan repayments is thought to be in, or at risk of, mortgage stress.

Some lenders and mortgage experts might roughly apply the 28% limit of an applicant's income when assessing their ability to service a home loan. But lending policies can vary from lender to lender.

In practical terms, if you're looking to spend 28% or less of your pre-tax income on mortgage repayments and you earn the average gross weekly income of $1,923 (according to ABS data, as at May 2024), you should be paying no more than $538 in weekly home loan repayments.

On an average annual income of $99,996, that's $2,331 per month. (Keep in mind there are 13 four-week periods in a year, so someone making monthly repayments may being paying less than someone making weekly repayments.)

See also: Fortnightly vs monthly repayments

To calculate what your own maximum repayment amount would be if you were to stick to the 28% income-to-repayment 'rule', multiply your pre-tax income by 0.28.

What is the threshold for mortgage stress?

Many people are surprised to learn of the prevailing definition of 'mortgage stress', according to the lending industry.

A household is typically considered to be in mortgage stress if it's spending more than 30% of its combined gross income on home loan repayments.

In dollar terms for the average wage earner, that means $579 or more in weekly home loan repayments puts you in the stress zone - a $41 per week jump from the optimum 28% figure.

Unfortunately, borrowers outside the stress zone can find quickly find themselves in it due to a rate hike or unforeseen circumstances such as a job loss or a large, unexpected expense.

If you're worried that changes to your interest rate could push you into mortgage stress, check out our guide on what to do if your home loan interest rate goes up.

Does the 28% rule always apply?

It pays to remember these figures are not hard and fast rules.

Some households, particularly those on higher incomes, may be comfortably able to afford to spend more than 28% or 30% of their pre-tax dollars on home loan repayments. This is because, if they have a larger amount of money coming in than the average income earner, they may still have enough cash left to meet their other spending needs.

By the same token, some households on lower incomes may struggle to make repayments even if they're 28% or less of their gross income.

The essentials can be the same or similar for households of various income levels, before taking into account any discretionary spending. For example, the cost of basic household groceries and other non-discretionary expenses can apply equally to both.

What else do lenders consider?

There are other measures that a lender will apply when determining whether it will lend to you and the size of the mortgage you will be able to afford.

Some are regulatory requirements and others may vary according to the lender's own policies. They include:

Serviceability buffer

The serviceability buffer is set by APRA and determines how much additional interest a bank must add to its current interest rate when assessing a borrower's ability to repay the mortgage they're applying for.

It aims to provide protection to borrowers, giving them a fair chance of being able to meet their repayments if interest rates were to go up, or if the applicant's income or living expenses were to change unexpectedly.

As at August 2024, the serviceability buffer set by Australia's banking watchdog is 3%.

In practical terms, that means banks, credit unions, and building societies must add 3% onto the interest rate they're going to offer you when determining whether you'd be able to meet your repayments if rates was to rise by 3%.

So, if you were applying for a home loan with a 6% p.a. interest rate, a bank would be required to do their calculations on your repayment capacity as if the interest rate was 9% p.a.

Non-bank lenders are also expected to apply serviceability buffers to comply with their regulator's (ASIC's) responsible lending laws.

Debt-to-income ratio

The debt-to-income ratio (DTI) measures the proportion of debt a borrower has compared to their income. This takes into account all debt, not just home loan debt.

This can include debt from credit cards, personal loans, tax debts, and even buy now, pay later accounts.

The ratio can help a lender decide whether a borrower will be able to afford the home loan.

DTI is calculated by dividing all your debt (including any proposed home loan) by your gross income.

As an example, if you are looking to borrow $600,000 and you already have a $35,000 car loan and $20,000 in credit card debt, your total debt would be $655,000.

On the average gross annual income of around $100,000, that gives a DTI of 6.5.

Every lender has its own policies on what it considers workable, but here are the general classifications:

  • Low DTI: 3.0 or below, considered excellent

  • Medium DTI: 4.0 - 6.0, considered good but not excellent

  • High DTI: 7.0 - 9.0+, considered risky

A DTI of 6.5 may see some lenders hesitate to approve you for a home loan without reviewing your individual circumstances further. Other lenders may consider that an acceptable risk.

Lender policies

Lenders will also consider a number of other factors according to their own policies and your individual circumstances. These include:

What to do if you're above the 28% home loan repayment threshold?

If you are applying for a home loan that will see you above the 28% threshold, there are several things you might consider doing that could put you under the threshold, such as:

  • looking for a cheaper property

  • improving your credit score (which could also help you secure a home loan with a lower interest rate)

  • extending the term of your home loan

  • fixing your loan at a lower interest rate

  • splitting your loan

See also: How can I structure my mortgage to lower interest repayments?

Our home loan calculators can give you a good idea of your borrowing power and help you determine the mortgage repayments that will best fit your circumstances.

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