The amount you can borrow and the amount you should borrow are sometimes two very different things. Before you apply for a home loan, it makes sense to realistically assess your financial situation.
Here’s how to do it.
Understand your borrowing capacity
Generally speaking, your borrowing capacity – what you can borrow – depends on a number of factors, including:
- your income
- your monthly expenses
- your existing debts
- how much deposit you have saved
- current interest rate
- type of loan
- whether it’s a principal and interest, or interest only loan
- the term of the loan
- estimated repayments.
However, knowing the difference between what you can borrow and what you should borrow is very important. As a general rule, it’s not a good idea to allocate more than 30% of your monthly household income to repaying your home loan.
Build a budget
It is a legal requirement under Australian Responsible Lending Legislation that lenders do not put their clients into a loan they can’t afford. A fundamental part of this is making detailed enquiry into your monthly living expenses.
To fully understand what your realistic borrowing limit might be, first of all create a budget – and stick to it. Once you understand exactly what’s coming in and going out you can properly assess how much you can afford to repay – and therefore what you should borrow.
If you don’t feel comfortable drawing up the budget yourself, it’s wise to seek help. A financial planner can assist you in preparing a budget.
Expenses to include in your budget include, but are not limited to:
- council rates
- body corporate fees (if applicable)
- insurance costs
- maintenance costs
- utility bills
- estimated groceries
- medical bills and health fund payments
- school fees
- phone and internet costs
- petrol and transport payments
- entertainment, travel and clothing
- other loans or credit card debts.
You may find this tool on the Moneysmart website useful in calculating your monthly expenses.
Future-proof your figures
Remember to leave a bit of wiggle room in your budget in case circumstances change. People can lose their jobs or get sick, or interest rates can rise, which could impact your ability to honour your repayments.
It’s also important to think about some other things that may happen: Is your income likely to increase within the next few years? Are you likely to have children and lose an income? Do you plan to retire shortly? These are all questions that only you can answer and they will all have an impact on how much you should borrow.
Remember, lenders tell you how much you can borrow, but you know your personal circumstances better than anyone else – it’s up to you to decide how much you should borrow.
Please don’t hesitate to contact me if you have any questions regarding any of these points.
