First Home Buyer
Buying Your First Home
Stage 2: Work Out Your Borrowing Power
When applying for a home loan, the amount that you can borrow may be different from the amount that you actually should borrow.
When a lender works out the maximum amount that you can borrow, it is based on a set of numbers: your income, your expenses, your assets and your debts. They can’t take into account your personality. Only you know the kind of lifestyle that you want, how disciplined you are with your finances and if there are any major life changes that might be on the horizon, like starting a family or quitting your job and starting a new business.
For first home buyers, lenders look at three things to decide if they will lend the money and how much they will offer:
- Genuine Savings
Broadly defined, serviceability is your ability as a borrower to meet loan repayments, based upon the loan amount, your income, your employment situation, expenses and other commitments such as credit card debt, personal loans and car loans.
The calculations for serviceability are a bit more complex than merely deducting expenses from income. Lenders in Australia tend to use one of the following methods for calculating serviceability:
Net surplus ratio (NSR) - This looks at the amount of money that you won’t be using to pay your debt and it expresses this as a percentage of your total after-tax income.
Debt servicing ratio (DSR) - This method calculates the percentage of income that will be used to pay your debt once the proposed home loan is factored in.
Uncommitted monthly Income (UMI) – This calculates the income you’ll have available each month after all expenses have been factored in, including proposed home loan repayments.
All lenders differ in how they assess serviceability and the way they work out your maximum borrowing power. However, regardless what the lenders say about your borrowing capacity, you need to be comfortable with your mortgage repayment and avoid “mortgage stress” which is when 30% or more of your income goes on your home loan repayment.
If you’d like to get a ball park figure on what you should borrow, you can use the “How much SHOULD I borrow calculator” that I have developed. You can access it from here.
Remember that the results are an indication only. They are neither a quote nor a pre-qualification for a loan.
A home loan deposit is your initial cash contribution to the purchase price of a property. It means that you own a small portion of the home.
Lenders use a Loan to Value Ratio (LVR) to assess how risky you are as a borrower. It looks at the amount you wish to borrow in relation to the value of the house you want to buy. The higher the ratio, the more risky you are as a lender.
Generally, I would suggest that you have a Loan to Value Ratio of 80%. This means you need a deposit of at least 20% of the value of the property. On top of that you’ll also need to have enough to pay stamp duty and legal costs. This will vary depending on which state you live in but a safe figure is 5% of the property value.
It’s a lot to save. So, why don’t people borrow more?
The reason for borrowing up to 80% of the value of the property and not more is to avoid Lenders Mortgage Insurance (LMI).
LMI is a fee charged by lenders to provide themselves with an extra level of protection in case you can’t pay your loan. It’s not cheap and the more you borrow, the more it costs.
LMI on a $300,000 loan, would cost between $10,000 and $15,000.
If you are willing to pay for LMI, you can usually borrow up to 95% of the property value. However, keep in mind that higher borrowing usually attracts a higher interest rate.
On the other hand, the good news is, if you have a bigger deposit and you borrow less than 80% of the value, you may even be able to negotiate a discounted interest rate from the lender.
Genuine savings is a term used by lenders to define whether the funds that you’re going to use as your deposit have been saved by you over a period of time. While different lenders have their own definitions of genuine savings, they all require evidence that you have held onto the money for a minimum of 3 months.
Your Genuine Savings can take various forms. They can be (this may vary between lenders):
- Savings such as Term Deposits or High-interest Savings Accounts accumulated or held over a period of 3 to 6 months
- Shares or managed funds which have been held over a period of 3 to 6 months
- A Monetary Gift. You’ll need to have a statutory declaration from whoever gave you the monetary gift saying that you don’t need to repay it. You’ll also need to have had control of that money for at least 3 months.
- Inheritance – If the money has been held for at least 3 months to 6 months
- Rental payment – If you are renting before you find your first home some lenders may accept this as genuine savings as you have shown a commitment to paying a regular fee. Once you have bought a home, the money you would have spent per week on rent can now be directed into paying your home loan. To do this you would need to show a perfect rental history.
Genuine Savings represent your deposit.
If you plan to borrow 95% of the property value lenders will typically ask for a minimum of 5% of the property price as genuine savings.
We’re here to help you
Dealing with banks can be a stressful experience but rest assured that our mortgage broker based in Glenelg (but our mortgage broker services the entire Adelaide Metropolitan area) can help you make the right decision about your mortgage. We will guide you at every stage of your loan process.
Contact us on 08 8376 0455 or drop into our office at 593 Anzac Highway, Glenelg SA 5045.
Any advice contained in this article is of a general nature only and does not take into account the objectives, financial situation or needs of any particular person. Therefore, before making any decision, you should consider the appropriateness of the advice with regard to those matters. Information in this article is correct as of the date of publication and is subject to change.