Before starting the process of searching for your next home, knowing the amount that you can borrow will allow you to determine your property budget. There are three factors at play:
The very first step in setting a budget for your next home is to determine the amount you are comfortable repaying each month. The higher the monthly repayments, the more difficult it is to maintain your desired lifestyle, or to save for other financial and investment goals. As a general rule of thumb, you don’t want to be paying more than 30% of your household income towards loan repayments – spending anything beyond this level would be considered “mortgage stress”.
How much you can afford to repay each month is one thing but lenders will test your repayment ability differently. Often you will find that you can only able a lessor amount than what you can afford to repay. This is because when assessing your application, lenders will test your repayment ability using an interest rate that is 2-3% higher than the actual rate. This added “buffer” means that if the actual interest rate is 5%, then lenders will test your repayment ability at 8% (i.e. 5% + 3%).
The available deposit you have is calculated by the amount of savings you have less transaction costs (e.g. stamp duty, legal fees) and your “saving buffers”. A savings buffers simply refers to the amount cash you want to have leftover after the purchase. As a rule of thumb, 3 to 6 months’ worth of expenses and loan repayments as a savings buffer is common.
A 20% deposit is the standard which lenders consider as a “safe deposit” level. Paying less than 20% usually comes with strings attached and one of these is Lenders Mortgage Insurance (LMI), which is a significant outlay.
If you have less than 20% deposit, your broker will be able to come up with solutions such as accessing any professional LMI waivers, using equity in your current home, arranging a family guarantee etc.
Tip: Working out the deposit you need is a balancing act, if you contribute too little of a deposit, you end up borrowing too much and risk high ongoing repayments that might restrict your lifestyle and other financial goals. On the other hand, if you contribute too much of a deposit, you risk depleting your cash buffer to ride out any unforeseen circumstances.
Having determined your borrowing power and the available deposit, you should then have some idea on the property budget that you can target. The following example will illustrate how this all works.
Johnny and Jane both earn a before tax salary excluding super of $200,000 each, so they have a combined household income of $400,000. They are married with one dependent, have $500,000 in savings and their goal is to upgrade their current apartment to a house.
Their current apartment has an outstanding loan of $405,000 with 25 years loan term remaining. If rented out, the proposed rental income would be $650 per week. They have no other liabilities.
To calculate the amount of loan repayments they can afford we start with their take home pay after tax which is $23,290 p/mth. After factoring in $6,000 for living expenses, $2,500 for regular investment in other assets, $4,000 of regular savings, plus $1,000 contingency savings for their plans for a second child, they have calculated an amount of $9,790 p/mth as the amount they would be comfortable repaying to the bank.
| Add or Subtract | Amount | Comment |
|---|---|---|
| + | $16,700 | Johnny's before tax monthly salary ex super |
| + | $16,700 | Jane's before tax monthly salary ex super |
| - | $5,055 | Less Johnny's tax |
| - | $5,055 | Less Jane's tax |
| Total | $23,290 | Total take home pay after tax |
| - | $6,000 | Less living expenses |
| - | $2,500 | Less investment in other assets |
| - | $4,000 | Less regular savings |
| - | $1,000 | Less contingency for second child |
| Total | $9,790 | Available budget for loan repayments p/mth |
Johnny and Jane are both experienced professionals with stable employment. So they have decided they’re comfortable with a 3-month savings buffer.
To calculate this, they add their monthly repayment expense of $9,790 to their monthly living expenses of $6,000. Multiply this by three equals $47,370 being their savings buffer. As they have $500,000 savings today, deducting the $47,370 savings buffer gives them an available deposit of $452,630.
| Add or Subtract | Amount | Comment |
|---|---|---|
| + | $600,000 | Savings today |
| - | $9,790 x3 | Monthly repayment budget (x3 months) |
| - | $6,000 x3 | Less living expenses (x3 months) |
| - | $5,055 | Less Jane's tax |
| Total | $47,370 | Savings buffer |
| Total | $552,630 | Maximum available deposit |
Next Johnny and Jane speak to an experienced broker.
They are advised their borrowing capacity is $1.6M to $1.7M depending on the lender, and assuming their current apartment is converted to an investment property. With $1.6M of borrowing power plus an available deposit of $552,630, they could achieve a purchase price of $2.0M.
This is reconciled as the $2M purchase price plus stamp duty and solicitor fees, less the $1.6M loan amount which equals a deposit of $500,508 they can cover with their maximum available deposit of $552,630.
They decided instead to contribute the full $552,630 available deposit, revising the loan amount down to $1,547,878 which brings the repayments to $8,789 p/mth. This repayment level is within the budget of $9,790 p/mth.
| Purchase price | $2,000,000 |
| Stamp duty (NSW) | $94,508 |
| Legal & other fees | $6,000 |
| Total costs | $2,100,508 |
| Loan to value ratio | 77% |
| Less loan amount | $1,547,878 |
| Deposit required | $552,630 |
| P&I monthly repayment at 5.5% pa (over 30 years) | $8,789 |
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