Today we will show you a VERY effective step-by-step strategy for working out how much home you can afford.
In fact, we have used these exact steps to help over 1,000 home buyers get their first house.
Let’s jump right in…
Table of Contents
Calculate how much you can borrow
1. How to use ‘How much can I buy calculator’?
Some banks call it serviceability, others call it affordability, and you might have heard it being called borrowing power.
But at the end of the day, all you want to know is – how much can I afford to buy?
Using our calculator, we look at what you’re currently paying in rent and your weekly savings, which is your surplus money after expenses. We use this figure to find your house price guide.
Follow the steps to work out your house price guide:
- Change your rental period to weekly, fortnightly or monthly (depending on how you pay rent)
- Enter how much you have in savings towards your deposit (if you aren’t sure how much deposit you need, look at our deposit calculator)
- Enter your deposit amount. We recommend a minimum of 8-10%.
- Now move the slider to be the amount you are paying in rent and savings per week, fortnight or month (depending on what you chose in step 1)
- Now, see your house price guide and the rough monthly repayments.
2. Determine your income versus expenses
Essentially, what you can afford depends on your current earnings and what you spend out of that. It’s all about your incoming versus outgoing money.
Nobody likes the B-word (budget), but realistically, this is what the next step is to start consolidating your spending.
Please speak to our team about this, as we truly have some thrifty savers at the forefront of Hunter Galloway.
As a general rule, you should use no more than 28% of your monthly income to make loan repayments. Although buying a house is a crucial investment, it should stay within your spending limit. Going beyond your limit can be risky, especially if interest rates increase.
Top tips for tightening your expenses:
- Write down all your expenses, including existing loans, car debt or credit cards.
- See what you can remove from your everyday life (small or big).
- Budget on a weekly basis to make it easier and more achievable.
- Calculate the28% of your income that will go towards your mortgage repayments [example below]
If you earn $850 per week (after tax), then 28% would be $238. This is the amount you want to pay towards your mortgage to stay within your spending limit.
If you want to buy something nicer but cannot afford it, consider buying with a partner or family member to make your repayments more affordable.
3. The bigger deposit – the more you can afford
The more you can save, the better off you’ll be. As the example above shows, if you aim for 28% of your income for the repayments, it actually isn’t a lot.
However, a bigger deposit will help you increase your borrowing capacity and reduce your loan. It also means that you won’t need to pay lenders mortgage insurance (LMI). Generally, if you have less than a 20% deposit, you’ll need to pay LMI, so to remove this extra cost, save a bigger deposit.
Ideas to increase your deposit:
- If you already own a home – you can use the equity in your current property to increase your deposit.
- Any financial gifts can help increase your deposit and get you ahead.
- Learn more about lenders mortgage insurance here
4. Practice your monthly mortgage payment
If you’ve decided to hold off on buying for a little while, then consider practising your mortgage repayments ahead of time so you can truly understand how buying a home will affect your monthly budget.
This is especially appropriate for those whose estimated mortgage is higher than their rent. So, for the next few months, start putting away the extra money that you’d put towards your mortgage repayment to simulate making that payment and see if your budget feels comfortable.
If you’re struggling, then it’s time to reconsider what you can afford.
The strategy, in summary, is:
- Start putting away the same amount of money as your mortgage repayments to simulate it.
- Review after 3 to 4 months and see if you can afford it.
Read More: What to know about applying for a home loan
5. Calculate your debt-to-income ratio
Now it’s time to be brutally honest with yourself, and a word of warning – it may end in tears, but you’ve got to do it (sorry).
Your debt-to-income ratio requires you to figure out all your monthly debt payments (car loan, credit card bills and future mortgage payments) and divide it by your gross monthly income (what you earn before taxes).
The lower your DTI is, the more financing options you will be able to access.
Certain lenders apply a DTI limit, including Commonwealth Bank, National Australia Bank and Non-Bank lenders, which means that they set a cap on how high the applicant’s DTI can be in order to qualify for the loan.
Let’s look at how DTI works.
For example, you’re a couple earning a gross income of $50,000 per year each ($100,000 in total), and you’d like to borrow $350,000. You worked out your total liabilities as follows:
$350,000 for your new mortgage + Credit card monthly limit of $1,000= Total debt: $351,000
Now it’s time for the mathematics:
$351,000 (debt) ÷ $100,000 (total income) = 3.51 DTI
So in simple terms, your total debt is 3.51 times your combined income.
Is 3.51 a high DTI?
The above example is mostly considered to be normal.
Generally, a DTI higher than 6 times the borrower’s income (6 DTI) is considered high risk. This DTI would put the borrower under a lot of financial stress if their financial situation changed suddenly or if interest rates rose.
6. Get your free credit score
Your credit score affects your borrowing power, so if you’ve got bad credit, then it’s time to turn this around.
Credit scores are calculated on your history of repaying loans and bills and how many times you’ve applied for credit.
If you’ve defaulted on a loan in the past or been bankrupt, then this will affect your score.
Tips to help your credit score:
- Consolidate debt and try to pay it off as quickly as possible.
- If you have any defaults or bad credit ratings, contact the company directly to see if they can remove this for you.
Hunter Galloway can send you your free credit score to help get this step moving.
7. Be aware of your credit score and how it affects your borrowing power
There are a few factors that come with borrowing money, and one of them that’s often forgotten is how important the good ol’ credit score is.
As we mentioned above, your payment history matters, especially whether you’ve been on top of your payments in the past. However, a lender will also consider all your other types of credit (credit cards etc.) when determining how much you can afford.
So even if you have a credit card sitting around gathering dust with a $20,000 limit on it, this will significantly affect how your lender perceives your application.
Because, essentially, in their eyes, nothing is stopping you from going out and dropping that $20,000 on a new car tomorrow.
Credit cards can massively reduce your borrowing power. Broadly speaking, a $10,000 limit credit card can reduce your borrowing capacity by between $30,000 to $50,000!
- Remove any credit cards you are no longer using – even just having them open affects your borrowing capacity.
- Review your financial situation, and close any credit accounts you don’t really need that are still open, e.g. some buy now, pay later services like AfterPay.
8. Carry Out Thorough Research
It’s time to conduct detailed research to determine market prices and rates.
Comparing home loans will enable you to make the right decision and find out the maximum loan you should borrow that allows you to live comfortably.
For example, you wish to borrow f $300,000 and have to make a monthly repayment of $2,000 based on the lender and cash rate.
Before you sign up for it, ask yourself the following questions:
- Can I afford it?
- Can I pay the monthly repayments?
- Can I manage my other living expenses with these repayments?
If the answers to the above questions are yes, then you’re in the clear. But if you answered no to a single question, then consider postponing the decision to buy a house until you are ready.
Speak to our team about creating a budget plan and helping you figure out what you can afford.
Read More: How much will my home loan repayments be?
9. Find a loan package that suits your financial goals
There are several home loan packages in the market. Every individual’s financial situation is different, so a single home loan may not be suitable for everyone. Therefore, it is important to find a package that suits your financial goals. If you’re a first-home buyer and need a complete guide, you can find that here.
The following are a few things you need to consider when finding a loan package:
- What interest rate should I use? When buying a house, borrowers have the option to choose a variable interest rate or a fixed interest rate. Your mortgage broker will be able to provide you with information on both options to help you figure out which one is best for you.
- What should the loan terms be? Most home loans have a term period of 30 years or more. However, you can even choose a term of up to 40 years – the maximum term period offered in Australia. Remember that your repayments will be higher if the term period is short. However, if you pay off the loan faster, the overall cost will reduce as you will have to pay less interest.
- Devise a Strategy. If you have devised an effective strategy, you will be able to repay your loan efficiently. Consult your broker to devise a good plan and come up with an effective strategy on how you will pay off your loan and which interest option is best for you.
The reality is different loans are going to suit different people.
Next steps and getting your home loan
Our team at Hunter Galloway is here to help you buy a home in Brisbane. Unlike other mortgage brokers who are just one-person operations, we have an entire team of experts dedicated to helping make your home loan journey as simple as possible.
If you want to get started, please give us a call on 1300 088 065 or book a free assessment online to see how we can help.