Real estate continues to dominate the headlines in tandem with speculation on the future of the housing market as the banking regulator's crack down on interest-only loans begins to bite.
Bank of Queensland chief executive John Sutton was front-page news last week when he revealed that some of his competitors were offering maximum loans of up to 30 per cent more than his bank was prepared to write. He finished with a timely warning: "This will end in tears."
More National News Videos
Turnbull won't budge on housing affordability
Prime Minister Malcolm Turnbull is taking a wait and see approach on housing affordability, despite a public warning from the Reserve Bank about rising household debt.
To test the veracity of that statement I spoke to a friend who works for one of the major banks. I asked him to run the numbers to let me know how much his bank would lend to a couple earning $85,000 a year each, with an adequate deposit and no debts. I was astounded to learn they could qualify for a loan of $1 million.
Let's do the calculations with the figures rounded for ease of reading. Income tax including Medicare Levy on an $85,000 a year salary would be $21,000. Therefore, our hypothetical couple should be receiving combined take-home pay of $128,000 a year.
![It's better to trim your sails than suffer mortgage stress or worse, a distressed sale.](/web/20170409012630im_/http://www.theage.com.au/content/dam/images/g/m/w/t/p/g/image.related.articleLeadwide.620x349.gvfdf3.png/1491515785436.jpg)
The repayments on a $1 million loan at 4.5 per cent a year would be $5100 a month, or $61,000 a year, leaving just $67,000 a year for all other expenses. Obviously, personal discretionary expenses can vary enormously between households, but a recent study on retirement showed that a retired couple could expect to spend about $54,000 a year. Those figures were certainly not based on an extravagant lifestyle, with clothing costs estimated at $58 a week, and leisure at $173 a week.
However, for the sake of the exercise let's assume our working couple live fairly frugally, and spend $60,000 a year. That leaves just $7000 over for contingencies such as holidays, house maintenance and vehicle replacement.
You could take an optimistic view and argue that a couple could get by quite reasonably in this situation, but all borrowing examples need to be stress tested. The obvious first question is: what happens if interest rates rise to 6 per cent? If that happened, their repayments would jump to $6000 a month, taking $12,000 a year from their cash flow. Just that relatively small rate rise could put them under water.
We must also think long-term, and accept the fact that many couples aim to have children. The repayments I have used are based on a 30-year term – this means the mortgage does not reduce much in the early years. In fact, at 4.5 per cent, after five years of payments totalling $306,000, the debt would still be $912,000. Even at today's low rates of interest, this couple could not cope if one of them had to give up their job – and they might have to do so for a range of reasons other than starting a family, such as ill-health or lay-offs.
The lesson here is that anybody considering buying a property should base the amount they borrow on their personal circumstances, and not on some hypothetical figure the bank's computer spits out. You need to prepare a simple budget, leaving some room for the unexpected items that are bound to come up, and then calculate how much of your take-home pay would be available for loan repayments. You should also allow around $4000 a year for the ongoing non-mortgage costs of home ownership.
Once you have determined a monthly mortgage payment that seems comfortable, you then figure out the amount you could borrow using a factor of $600 per $100,000 loan per month – this would repay a loan in 30 years at 6 per cent. For example, if you worked out you could afford to repay $3000 a month, the maximum you should borrow would be $500,000.
If a loan of that size won't buy the house you want, you need to review your options. Save for longer, rent instead of buy, or choose a cheaper house. Any of these are better than suffering mortgage stress, or worse, the stress of a forced sale.
Noel Whittaker is the author of Making Money Made Simple and numerous other books on personal finance. His advice is general in nature and readers should seek their own professional advice before making any financial decisions. Email: noel@noelwhittaker.com.au
0 comments
New User? Sign up