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Understanding loan affordability for first home buyers

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Understanding your borrowing power and loan affordability is paramount to knowing what kind of property is a realistic purchase for your personal situation.

 It’s lovely to dream about the white picket fenced four bedroom house in the next suburb or the penthouse apartment with ocean views near your favourite cafe, but if your affordability has been deemed by the bank as ‘x' then that’s actually what you can afford, even with a reasonable deposit or parents willing to act as guarantors or even gift you hefty sums of cash.

Of course, there are ways to minimise the costs associate with purchasing a property and there are even techniques to reduce the amount of interest you pay over the life of the loan. For example you can avoid lenders mortgage insurance (designed to protect the lenders not the buyer) if you borrow no more than 80% of the purchase price; or you can secure your mortgage using the equity from property owned by your parents through loans products such the Endeavour Mutual Hamily Helper Loan. Stamp duty is an expensive add on to any property purchase, but depending on what state you live in, whether you are a first home owner or purchasing a new build, you may be able to minimise these costs. You can also reduce the amount you pay in interest over the life of your home loan (saving you potentially thousands of dollars) if you pay it off before the loan period ends and top up loan repayments whenever you have a minor surge in cash.

However, your loan affordability is determined by your income (or collective income if purchasing with someone else), and unless you get a significant pay rise, or someone else joins the property purchasing party with you and adds a chunk of earnings potential to your borrowing bowl, a lender will only lend you what they think you can realistically pay off with your existing wages. While a $10,000 cheque from Dad for your 30th will do wonders for your deposit, it won’t actually alter your affordability too much in the eyes of a lender. However, the larger the deposit, the less you need to borrow, so if looking to enter the property market, having a savvy savings strategy and a determined deposit-building demeanour will certainly help you along your property purchasing pilgrimage.

In addition to this, Scott Pape from the Barefoot Investor cleverly suggests the 20-10-30 rule, arguing first home buyers should aim for: 

  • A 20% deposit
  • The ability to pay 10% interest rates (if needs be) - rates are about 4% at the time of writing but buyers should always assume rates will rise at some point during the life of the loan and allow for the worst case scenario 
  • Mortgage repayments should ideally be less than 30% of your net pay

Now this rule obviously errs on the side of caution, but caution never killed any cats as far as I know…

So before you start visualising your favourite artwork on the lounge room walls of that nice terrace for sale down the street, go chat to a mortgage specialist and figure out with them exactly what you can comfortably borrow, taking into account potential interest rate hikes, cash flow fluctuations and leave room to breathe so when you can, boost your repayments with extra deposits from time to time.  For peace of mind and a secure future It's better to enjoy that piece of art on the wall of a property you can actually afford.  

 

Alison Gallagher is a freelance writer, resourcefulness expert and entrepreneur. She has been featured in various publications including Stellar Magazine, Australian Health and Fitness Magazine, and Cleo Magazine. Alison is particularly passionate about sharing practical tips on how to live simply, sustainably and seasonally.