Securing a mortgage to purchase a house is a significant financial decision that involves understanding several key factors, the primary one being mortgage affordability.
This key component determines how much you can borrow from a lender while ensuring that the repayment is balanced with your finances.
This blog post will delve deep into mortgage affordability, how lenders in Australia calculate it, and why it’s so essential to the home-buying process.
Let’s dive into the details.
The Basics: Mortgage and Affordability
First things first, what’s a mortgage? Well, it’s a loan you take out to buy property or land, repaid over a long period of time, typically 25–30 years.
Affordability, as the term suggests, indicates your financial capability to repay the mortgage without stretching your budget.
Mortgage lenders, the financial institutions providing these loans, hold the reins of this process.
Understanding the Affordability Assessment Process
There are generally three stages to the affordability assessment process:
Stage 1: The Income Assessment
The first step involves tallying all your income sources. Your regular salary is the primary component, while other income, like property rent, also counts.
Stage 2: Expenditure Assessment
The lenders then assess your living expenses and any existing financial obligations. The goal is to ascertain how much disposable income you can comfortably allocate towards mortgage repayments.
Stage 3: Stress Testing
This is a prudent step taken by lenders to see how well you could cope with your mortgage repayments if there were changes in circumstances, such as cash rate hikes and subsequent interest rate increases. They want to ensure that you’re not put in a precarious position if conditions change.
Factors That Influence Your Mortgage Affordability
During each assessment stage, lenders will consider factors influencing your mortgage affordability and how much you can comfortably borrow from them.
Each element plays a fundamental role in the overall calculation, and together they create a comprehensive picture of your financial capability to take on home loan repayments.
These factors include the following:
- Income: Your income is a major factor in determining your borrowing capacity. Lenders look at both the amount and the stability of your income. They’ll consider your salary and any additional income, such as bonuses, rental income, or investments.
- Debt repayments: Lenders will also examine your existing debts. If you have high levels of debt, it may limit the amount you can afford to borrow. This includes credit card payments, student loans, car loans, and other financial obligations.
- Credit history score: Your credit score is essential to the affordability equation. A high credit score makes life easier when it comes to securing a mortgage and often allows you to secure a lower interest rate. This then increases the amount you can borrow.
- Deposit: The size of your deposit also impacts mortgage affordability. A larger deposit reduces the amount you need to borrow and can make a mortgage more affordable. It can also help you secure a better interest rate.
- Monthly expenses: Lenders will consider your regular living expenses, including bills, groceries, transportation costs, and other recurring expenses. This helps them understand how much money you have left over each month to put towards mortgage repayments.
Case Study: How a Mortgage Lender Assessed a Client’s Affordability
Alex is a full-time IT professional with an annual salary of $85,000. He also earns about $15,000 yearly from a rental property, bringing his total annual income to $100,000.
He has a credit card debt of 5,000 and a car loan for which he pays $500 a month. His credit score is good, and he has saved up $140,000 for a home deposit.
His monthly living expenses, including utilities, groceries, and transportation, amount to $1,500.
In the income assessment, the lender will consider Alex’s primary and additional rental income.
The lender would positively assess Alex’s stable IT job and consistent monthly income from his investment property, showing a good track record of steady income.
Next, the lender will consider Alex’s existing financial obligations, credit card debt, and the car loan, which he steadily pays off.
They subtract these debts from his income and living expenses to see what’s left for potential mortgage payments. Despite these obligations, Alex still has a significant portion of his income available for mortgage repayment, making him a viable candidate for a mortgage loan.
In the final phase, stress testing, the lender will consider hypothetical scenarios that could affect Alex’s ability to meet his mortgage payment obligations. For example, one such scenario could be the loss of his rental income.
In this case, even if Alex were to lose the additional $15,000 in income from his rental property, his primary income from his IT job still leaves him with sufficient means to handle his mortgage repayments, living expenses, and existing debts.
This shows his financial resilience and contributes positively to his mortgage affordability.
Based on his affordability assessment, the lender offered him a loan of $560,000 with a 30-year loan term and a variable interest rate of 3.5%. So he would have an estimated $2,515 monthly mortgage payment to cover.
Remember, each lender may weigh these factors differently, so you must discuss your individual circumstances with a mortgage broker to find out how much you can afford to borrow.
Improving Mortgage Affordability: Some Handy Tips
If your affordability isn’t where you’d like it to be, these strategies could potentially help improve your borrowing position and make the process of securing a mortgage more manageable:
- Boost Your Income: Think about ways to raise your income, like requesting a raise, looking for a job that pays more, or starting a side business.
- Reduce Existing Debts: Pay off high-interest debts like credit cards or personal loans to lower your financial commitments.
- Maintain a Good Credit Score: Pay all bills on time, refrain from using too much of your available credit, and promptly correct any errors on your credit report to improve your score.
- Save a Larger Deposit: A larger deposit can reduce the loan amount you need, potentially securing a lower interest rate and making the mortgage more affordable.
- Manage Your Living Expenses: Keep regular outgoings in check to ensure more disposable income is available for mortgage repayments.
- Understand Lender’s Criteria: Every lender is different, so understand their specific affordability criteria and work towards meeting them.
Understanding how mortgage lenders calculate affordability is key to successfully navigating the path to homeownership in Australia.
Here are some key takeaways:
- The affordability assessment process ensures you can comfortably manage your mortgage repayments.
- Your income, existing debts, credit score, deposit size, interest rates, and living expenses are all significant factors in determining your mortgage affordability.
- You can enhance your mortgage affordability by increasing your income, reducing your debts, maintaining a good credit score, saving a larger deposit, managing your living expenses, and understanding your lender’s criteria.
- Every individual’s situation is unique, so you must seek personalised advice from a mortgage professional to make the most informed decisions.
Ready to turn your homeownership dreams into reality?
Let The Mortgage Agency guide you through every step of the process. Our experienced professionals are committed to helping you understand mortgage affordability and secure the best possible loan for your circumstances.
Contact us today.