Puzzle Finance Blog


Don't get in over your head


When taking out a mortgage, work out exactly what you can afford.

One of the worst nightmares for any mortgage holder has to be defaulting on the loan repayments and having the property repossessed by a lender. It would also be a very bad look for the lender.

But that is exactly what can happen if you take on a loan you cannot service.

The best way to avoid such a situation is to be as prepared as you can for what can easily be one of the biggest financial commitments of your life.

There are plenty of online calculators that help you work out how much you can borrow but it's important to know how much it is wise to borrow.

The founder of Housing Loans Australia, Greg Marshall, says lenders have a tight rein on assessment and serviceability issues when it comes to loans.

''Their main objective is to provide funding to clients who they believe can service the housing loan without undue hardship given normal circumstances,'' he says. ''The last issue any lender wants is to follow up late repayments on a regular basis and certainly not the adverse press of tossing the poor old household out on the street.''

The assessment

The chief executive of Resi Mortgage Corporation, Lisa Montgomery, says every financial institution assesses people's serviceability differently, so how much you can borrow may change from lender to lender.

While calculators will go some way to determining what someone can borrow, only you know what is a safe amount.

''It is important to have a close and honest look at your personal situation so you can be the best one to determine what you can realistically and honestly manage,'' Montgomery says.

''Even though you may be able to borrow a certain amount, only you will understand what really goes on with your spending.''

When someone goes into long-term debt, particularly first-time borrowers, they need to know they can make the commitment month in, month out, for years.

Personal circumstances can change, as can priorities, but the loan repayments still have to be made.

Think about what might happen if you lost your job or wanted to go travelling. Factor in how you might cope if interest rates rise by, say, 2 per cent.

''It is critical for every borrower to understand that interest rates, like property prices, are cyclical, so you need to be comfortable with your financial situation, not only now but in the future,'' Montgomery says.

Lending criteria

Online calculators assessing how much a person can borrow generally consider your income, household size (single or couple, number of dependants) and existing loan commitments.

They may or may not ask for your living expenses. This is because some calculators use built-in estimates of average living expenses for different household types.

Loan calculators also generally regard the bulk of income after tax and living expenses as being available for debt servicing.

In real life, the assessment needs to take into consideration not just your income and regular expenses, including any credit arrangements, but also where you are in your life cycle, Montgomery says.

''This can take into account … how many children you have and how long you are likely to continue working,'' she says.

Lenders also consider estimated future income and overall spending patterns.

''You need to be accurate, open and honest with your lender about this information as the person who will be most affected if you're not is you,'' Montgomery says.

The chief executive of Teachers Credit Union, Steve James, says there are four main criteria a potential borrower will be assessed on: the amount and stability of income; the capacity to repay the loan (income versus expenses); future plans, such as starting a family; and credit history.

''When we're assessing a potential borrower, it's important to us to make sure they can cope with their repayments, within their lifestyle,'' he says.

''That approach has stood us, and our borrowers, in good stead.''

By the numbers

Accountant George Psarakis is used to crunching numbers. So when it came to working out how much he could borrow from the Teachers Credit Union to buy an investment property, the 27 year old thought he had everything worked out.

He felt sure part of the lenders' assessment of the loan would include the rent from the property he was buying.

"I knew I could afford the loan on my income alone but I thought they'd need the rent to get the loan over the line," George says.

The news from the mortgage broker was that the rent wasn't included.

On his own calculations and using various bank and credit union websites, he worked out he probably could have borrowed more than he needed.

However, he had already found the unit he wanted to buy and knew exactly how much he needed to borrow and could easily service.

"It helped that I didn't have a credit card or any other debt," George says.

Posted by Bina Brown - The Age Money on 8th January, 2012 | Comments | Trackbacks
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