What size mortgage can you afford?

By Peter Boehm

Home ownership is a big part of the Australian psyche and many Australians are prepared to take on massive mortgages to buy a place to call their own.

Part of the trouble with the home buying process is that it's an emotional rollercoaster - and when emotions are high we don't always make the best decisions.

The pressure is to buy big and it's the task of real estate agents to sell their properties: encouraging us to spend as much as we can afford.

Of course, the trouble with buying ‘the best house on the street' is that you need the biggest and best mortgage on the street to pay for it.

How much debt can you afford?

It's imperative to understand that there's a big difference between how much money a mortgage company will offer you and the amount of debt you might actually be comfortable taking on.

How much can you actually afford?

There's only one person capable of answering that question: you. You'll find a heap of advice from various parties on the amount of money you can borrow, but you have to do the maths yourself - don't rely on somebody else to tell you.

For a ballpark idea of what sized mortgage you can comfortably afford, start by using some online tools. There are a wide variety of mortgage calculators that will provide you with some idea of how much money you can - but not necessarily how much money you should - borrow.

But be aware that these calculators are only a quick guide. They don't always allow for the fact that interest rates are likely to vary over the loan term, and they can sometimes offer larger sums that you will actually be able to afford.

Lenders use much more details tools when deciding what sized mortgage they think you can afford - usually taking into account your credit card or other debts, as well as any dependents.

Always be very aware that these calculations determine only how much you might borrow. They don't necessarily make provision for the costs of an enjoyable lifestyle, such as a meal on the town, a movie, a football game or a holiday. If you don't want to become a virtual slave to your mortgage, these expenses need to be part of the equation.

Doing the sums

There are some basic ‘rules of thumb' you can apply when deciding what percentage of your income you can spend on mortgage repayments. In the US and Canada, the recommended percentage usually falls between 28 and 36 per cent.

In Australia, it's generally felt that anything over 35 per cent is dangerous and likely to end in mortgage stress. Some people do pay more than this because they think they can afford to.

But, at the end of the day, it's only you who can decide what ratio you're comfortable with. It will probably depend on your earnings, but in an ideal world the ratio should be under 30 per cent.

Be certain to use your after tax income when you do your sums and not your gross figure - you can only make your mortgage repayments after you've paid your tax.

When you start deciding what sized mortgage is best:
- Create an in-depth budget based on your current spending habits while searching for any expenses you can slash.
- Factor in a 1 to 2 per cent interest rate buffer.
- Make room in the budget for the arrival of children, for taking holidays and for unexpected costs.

Life is much more than four walls

When doing your calculations, keep the following in mind:
- As much as you want a place to live, you'll also want some enjoyment in your life. If you over-extend, you'll be in danger of becoming a slave to your loan.
- You can always lower the size of your mortgage by saving a bigger deposit (see our article Saving for a home deposit).
- Work with your net after-tax income, not your gross pre-tax salary.

Above all, once you're out looking at properties, don't let yourself be ‘up-sold'. You've already decided the type and size of home you can afford, so don't let anyone convince you to buy a bigger house that will require a bigger loan.

Remember: it's going to be you who has to meet each of those mortgage repayments. While a lender will offer you an amount, it's up to you to say how much you can actually afford.



Thinking about buying a home? Visit Our Home Sweet Home for information on home buying, home loans and more.


Important information:
This information should be used as a guide only. It is neither the provision or legal or financial advice. No warranties are given as to accuracy or completeness. You should seek your own independent legal and/or financial advice.