What you can borrow Versus What you can AFFORD to borrow

Recent statistics show that rates of household debt are at all-time highs in Australia. Given that mortgage interest rates sit at all-time lows it is critically important that all mortgage borrowers understand the fundamental difference between what your lender will allow you to borrow, as compared to what you can comfortably afford to borrow.

To illustrate my point, as a general rule of thumb your lender will consider the following points (not an exhaustive list) when assessing your loan application;

• Your and/or your partner’s current income levels
• Your and/or your partner’s current debt levels
• Your deposit and/or equity contribution
• Current other fixed commitments (e.g. School fees, maintenance payments)
• The proposed loan term (usually 30 years)

 
The critical learning here is that your lender is obligated to make their assessment of your borrowing capacity based on your current financial circumstances, and current market interest rates.

From your lender’s perspective, your maximum borrowing capacity is therefore based on your current financial circumstances, plus a margin (the calculation will vary from lender to lender) that theoretically allows for future interest rate rises. 

The lender’s initial affordability calculation doesn’t consider the following – How many times during 30 years might your financial circumstances change?

Mortgage stress will generally occur as a result of a change in a borrower’s income circumstances and/or as a result of increases in the interest rate on your loan.
​
Some of the common examples of a change in household income and/or expense levels include;

• Job loss/change
• Birth of a child
• Change of relationship status
• Education expenses
• Committing to further debt obligations (e.g. car loan)

Borrowers need to understand that not only do you have to be able to comfortably afford your loan repayment at the commencement of the loan; it can potentially take 30 years to repay your home loan.

In my opinion it is very important when committing to a home loan to recognise that home loan interest rates currently sit at all-time lows, with current owner occupied variable rates sitting somewhere around the 4.00% to 4.50% range.

To clarify my point, please refer to the following table;

• A variable rate loan of $250,000 over 30 years with an interest rate of 4.50% - minimum monthly payment required is $1267
• A variable rate loan of $250,000 over 30 years with an interest rate of 7.00% - minimum monthly payment required is $1664

As can be seen from the example above, if over time there was a 2.50% increase in the variable rate it would lead to an increase in minimum monthly repayment of $397.

A potential adverse change in a borrower’s income circumstances, along with a potential upward change in loan interest rate will often lead to a case of mortgage stress.

Obviously no-one has the ability to be absolutely certain of their future circumstances, however in my opinion the critical question around housing affordability becomes – Can I afford my home loan both now and into the future, whilst maintaining the lifestyle I wish to lead?

A wise home loan borrower will generally consider both their existing financial position, and their likely future capacity to remain financially comfortable when entering into such a large and important financial commitment as a home loan.

To learn more about the effects of interest rate changes on your borrowing capacity, and also to get help to build a sustainable budget that can withstand other potential negative influences on your financial wellbeing contact Leigh at Empower Money Management today.
 
M.        0407 439 827
leigh@empowermm.com.au
www.empowermm.com.au