loans mortgages and how to borrow
Generally speaking, most prospective homeowners can afford to finance a property that costs between 2.5 and 3 times their gross Income. Under this formula, a person earning $100,000 per year can afford a Mortgage of $250,000 to $300,000. But this calculation is only a general guideline. You can use DBIJ Finance mortgage calculator to estimate your monthly home loan repayments.
Ultimately, when deciding on a property, you need to consider are a few more factors. First, it’s a good idea to have an understanding of what Banks/ Lenders thinks you can afford (and how they arrive at that estimation). Secondly, you need to determine some personal criteria by evaluating not only your finances, but also your preferences and priorities.
Mortgages: How Much Can You Afford?
Lender’s Criteria
While each mortgage lender determines its own criteria for affordability, your ability to purchase a home – and the size and terms of the loan you need – depends largely on the following factors:
Gross Income is the level of income that a prospective homebuyer makes before taxes are held back to be paid to the ATO on your behalf by your employer. This is generally deemed to be salary plus any bonus income, this can include any part-time / Casual earnings, self-employment earnings, disability, alimony and FTB A/ B. Gross income plays a key part in determining the front-end ratio.
Front-End Ratio is the percentage of your yearly gross income that can be dedicated toward paying your mortgage each month. Your mortgage payment consists of four components (often collectively referred to as P&ITI: principal & interest, taxes, insurance & property insurance). A good rule of thumb is that P&ITI should not exceed 30% of your gross income. However, many lenders let borrowers exceed 30%, and some even let borrowers exceed 35%.
Back-End Ratio, also known as the Loan to Income Ratio (LTI), calculated as the percentage of gross income required to cover all your debts. Debts include Credit Card payments, child support and other outstanding loans (Car, personal loans, etc.). In other words, if you pay $2,000 each month to your liabilities and you make $4,000 each month, your LTI ratio is 50%: Half of your monthly income is being used to pay debt.
This is the bad news: A 50% Loan-to-income ratio isn’t going to get you your dream home. Most lenders recommend that your LTI should not exceed any more than 36% of your gross income. To calculate your maximum monthly debt based on this ratio, multiply your gross income by 0.36 and divide by 12. For example, if you earn $100,000 per year, your maximum monthly Loan expenses should not exceed $3,000 per month. The lower the LTI ratio, the better your chances are in getting your Loan approved by the lender & also have a choice.
Credit Rating. If one side of the affordability coin is income, then the other side is risk. Mortgage lenders have developed a formula to determine the level of risk for a prospective homebuyer. The formula varies but is generally determined by using an applicant’s Credit Score. An applicant with a low credit score can expect to pay a higher rate of interest on his/her loan.
At this point, we have to say: If you know that you’re going to be looking for a home in the future, work on your credit score now, ensure you are budgeting your expenses as the banks /lenders will go through all your transaction on your bank statement, also ensure there are no default or late payment fee charged on your credit Card or loan repayment accounts as this will affect your credit scoring. It is important that you keep a close eye on your credit report, which is available to by calling Equifax. If you notice that there are inaccurate entries in your credit report, it may take time to get them removed and you don’t want to miss out on that dream home because of something that is there for no fault of your own.
Down Payment is the amount that the buyer can afford to pay out of pocket from funds saved towards the purchase of the property, using cash. For example, if a prospective homebuyer can afford to pay 10% on a $500,000 home, the down payment is $50,000, which means that the homeowner must finance $450,000. A down payment of at least 20% of the purchase price of the home is typically required by lenders i.e. $100K, which is the minimum 80% LVR required to avoid paying Lender’s Mortgage Insurance (LMI), (LVR = Value of Property / Loan Amount) but many banks let buyers purchase a home with significantly smaller percentages as little as 5% saving i.e. lend for LVR up to 95% with LMI capitalised to the loan taking it to a maximum LVR of 98%. Obviously, however, the more you can put down, the less financing you’ll need, and the less you borrow, better the interest rate you pay to the Bank as many banks are now offering cheaper interest rates based upon funds borrowed or based upon LVR.
In addition to the amount of financing, lenders also want to know the number of years for which the mortgage loan is needed, depending on the age of the borrower. A short-term mortgage has higher monthly repayments, but it may be less expensive over the duration of the loan & interest paid over the term of loan.
How Lenders Decide:
Many different factors go into the mortgage lender’s decision on homebuyer affordability, but this basically comes down to income and debt, assets & liabilities. Sometimes we think our mortgage applications are judged by a person who uses a gut feeling rather than objective criteria, but in fact, even if your mortgage lender was having a bad day, you can be rest assured that much of the process is formulaic & automated.
A lender wants to know how much income an applicant makes and how many demands there are on that income, and the potential for both in the future – in short, anything that could jeopardize its ability to get paid back. Income, Credit History and Credit score & down payment or applicant’s contribution and monthly expenses are generally base qualifiers for financing, while LVR determine the rate of interest on the finance request itself & with some lenders your credit score & LVR also determine the interest rate being charged.
Personal Criteria:
The lender may tell you that you can afford a huge estate, but can you really? Remember, the lender’s criteria look largely at your gross pay. The problem with using gross pay is simple: You are factoring in money – often as much as 30% of your wages but at what rates of taxation, Voluntary Superannuation contributions to help support your future and private health Insurance premiums & Private Education fees for the dependents – that you don’t actually have the ways & means to sustain home loan repayments over a 30 year standard loan term. Even if you expect a refund on your annual tax return, that doesn’t help you now – and how much of tax will you really get back from the ATO?
The above information is only to help you understand & bust any myths out there but if you think this is all too much to take in, don’t worry too much as this is not everyone’s area of expertise or cup of tea. Leave it to DBIJ Finance Pty Ltd who will break this down by working with you & asking relevant information depending upon your situation & that is required to get your finances underway keeping you in the loop every step of the way & negotiate an interest rate that is cheaper than what you would have managed directly by approaching the bank as we have been doing this over the years, I encourage you to visit our customer testimonials whether it is a simple PAYG income earned be it as Full time or Part time or Casual wage or Complex financial situation we organise finance every day.