Alan Hartstein
Athena Cocoves
Before embarking on your great home ownership quest as a first-time home buyer, there are plenty of factors to consider when figuring out what amount your bank will lend you and, more importantly, what you can afford to borrow.
How to set a target price
A good starting point is to make a checklist of what you’ll need to consider and what your lender will consider regarding your borrowing power. Additionally, the more time you spend now doing some relatively simple research on the state of your finances, the easier filling out your loan application and gaining pre-approval is likely to be.
Income considered for a home loan
The first factor you’ll need to consider is income, which could come from various sources, though your primary source will be your principal type of employment, whether full-time, part-time or casual.
For most first-home buyers, this will consist of being a full-time employee of an organisation, which is easy for a lender to verify through payslips or a letter from your employer.
This process will be different if you’re self-employed as a freelancer, contractor or small business owner. You’ll need to provide evidence of your income through bank statements, tax returns and possibly a letter from your accountant who can attest to your regular income. Although if your would-be lender is also the bank where your pay gets deposited, the amount of paperwork required should be considerably less.
Additionally, if you supplement your income with regular work, such as overtime or a second job on the weekends, or through an eBay business or some other type of e-commerce, you should definitely include that on your loan application, as long as it’s easily verifiable.
If you run your own business and are deriving a regular income from it, you’ll need to provide quarterly business activity statements (BAS) to the Australian Taxation Office and pay GST, which a lender can easily verify.
Lenders will obviously apply their criteria on a case-by-case basis, but the higher the income, the better your chances of getting your desired loan amount.
Debts, liabilities, and other expenses
Lenders will want to know your monthly expenses or, put simply, how you’re spending your money. These expenses can include any existing debts, such as car loans, personal loans and credit cards, mobile phone and internet payments, private health insurance, electricity, food, and entertainment.
Maintaining as accurate a record as possible of your outgoings should save valuable time in the loan process. Use a personal budget to keep your cash flow well-documented and up-to-day.
Other hidden costs and fees may also impact your desired property’s affordability, such as annual rates, strata fees if you buy an apartment, and home and contents insurance. These could add up to several thousand extra dollars a year on top of your current debt burden that your lender may consider when assessing the final amount they are willing to lend you.
How much mortgage can I afford?
Buying your first home and becoming part of the ‘great Australian home ownership dream’ can be an exhilarating experience. But you still need to think with your head and not your heart if you want to live with some measure of financial comfort in your new abode.
So instead of focusing on what the bank will lend you, aka your ‘borrowing power’, you should focus on what you can actually afford.
This consideration is essential for first-home buyers, given the size of the financial commitment you’re taking on. Unlike living with your mates in a rented group house, taking on a mortgage is a huge commitment spanning 20 or 30 years, so you need to be acutely aware of the size of your new financial responsibility and what it entails.
Borrowing power vs. affordability
Australian lenders are generally responsible when it comes to mortgages for first-home buyers and anecdotally they have become more risk-averse post-Covid. Having said that, they are still there to make a profit and lending you more money means much more in interest repayments over the length of your mortgage.
So just because your lender offers you a million bucks that doesn’t necessarily mean you should take it. Mortgages take a very long time to pay back, usually between 20 and 30 years, and if interest rates go north and your financial circumstances go south, you could find yourself floundering.
Nobody wants to drown in debt, especially if you’re in a job you’re not overly fond of. One thing Covid has taught us is that job security in its pre-pandemic form no longer exists in a lot of industries, so focus on what you can afford, not what you can borrow.
» MORE: Should you buy or rent?
How to calculate what’s affordable
Once you’ve considered all the above, it’s time to calculate exactly how much you can afford. Loan calculators are a handy tool to assist you in arriving at a number, but you should always err on the side of caution when using loan calculators. Allow for some leeway to cope with whatever unforeseen circumstances may arise.
All major lender websites should include loan calculators that feature both borrowing power and an affordability feature, such as the one on Moneysmart’s website, where you can key in what you’d be comfortable paying back after taking all income and outgoings into account.
So, for example, if you have a $40,000 house deposit and are comfortable owing $600 a week on your mortgage after you’ve paid all your other expenses, you could afford to borrow just over $503,000, assuming a 30-year mortgage term with a current interest rate of 4%. However, if you wanted a shorter mortgage term, say 20 years, and were only comfortable paying off $500 a week, you could only afford to borrow $330,000.
Before deciding on the amount, you can play around with the numbers in these calculators and talk to a financial adviser or the lender to get a better idea of what’s comfortable for you.
Basing your home loan amount on your salary
Opinions also vary as to the multiple of your gross annual salary that you should be willing to borrow, but as a general rule of thumb, you should try and stay within five times your annual salary.
So, for example, if you are earning a gross annual salary of $90,000 and you are looking to purchase a property in Sydney with a 2045 postcode, and $2000 a month in expenses, the maximum amount you could borrow is $487,550, which is slightly over five times your annual income.
Once again, this is an arbitrary multiple and everyone’s situation will be unique, but once again it pays to be conservative when you key figures into loan calculators.
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