How much of your income should you spend on your mortgage?

Property prices may have started to retreat from their recent highs, but there’s no denying that buying a home has become an increasingly expensive endeavor in recent years.

In fact, since June 2020, the average Australian mortgage has jumped around 25% to over $600,000 according to figures from the Australian Bureau of Statistics.

Until recently, historically low interest rates have helped keep mortgage repayments manageable for most borrowers – even those with large loans. But that’s starting to change thanks to four consecutive cash rate hikes that quickly trickled down to mortgage rates.

As a result, prospective homeowners are now faced with both relatively high property prices and rising interest rates, raising the question: how much should you pay for your mortgage?

Ultimately, there is no hard and fast rule, so it will depend on what you can afford and what your lender assesses you can afford. That said, here are some indicators to keep in mind.

The 30% rule and mortgage stress

One of the most common numbers that comes up in the conversation about mortgage costs is 30% – that is, your housing expenses (whether rent, mortgage payments or other related costs) must not exceed 30% of your household income.

Following this idea, if your household income was $7,500 per month, you would want to ensure that your monthly mortgage payments did not exceed $2,250.

Today, 30% might seem like a bit of an arbitrary number, but it actually marks the line between what is and isn’t considered mortgage stress.

For example, the Australian Housing and Urban Research Institute (AHURI) reports that housing stress begins to occur when a household with an income in the bottom 40% of the income distribution spends more than 30% of this income to housing costs.

Of course, that doesn’t mean a high-income person would want to spend, say, 50% of their income on housing costs, especially when income can change over the life of a 25-year loan. But it’s also not necessarily bad to spend more than 30% of your income on repayments if you’re comfortable with it, or maybe even if you’re looking to pay off the loan faster.

Why Your Debt Ratio Matters

Another indicator, actively used by banks and lenders during the process of evaluating home loans, is the debt-to-income ratio (DTI).

“Lenders consider your income versus how much debt you owe and will need to be confident that you are in a comfortable financial position overall,” says Brodie Haupt, CEO and co-founder of digital loans and payments provider WLTH.

“They generally view borrowers with a lower debt-to-equity ratio as less risky and are more likely to approve their loan or offer reduced rates. Applicants with a high debt-to-equity ratio are often subject to credit constraints. stricter borrowing capacity and may be required to have a larger deposit.”

Here is an example. Say your household income is $150,000 and you are looking to take out a mortgage of $600,000, but you also have a car loan of $15,000 and credit card debt of $2,000. Your total debt ($617,000) would be divided by your income ($150,000) to give you a debt to income ratio of 4.1.

But how would that 4.1 number actually add up? Regulator APRA recently told lenders that it considers a ratio above six to be riskier at present given that incomes are unlikely to keep up with housing costs in the short term.

Although each lender has slightly different thresholds when it comes to assessing a borrower’s debt-to-equity ratio, says Rob Lees, director of Mortgage Choice Blaxland, Penrith and Glenmore Park, there is a tricky time when borrowers will start having a harder time getting approved.

“Generally, if your debt is less than seven times your income, you’ll be fine,” he says.

“It’s once you start going over a DTI of seven that it can become problematic. For example, if it’s over seven, they may not approve the loan if the LVR is over 80% and mortgage insurance is involved.”

debt to income ratio

How can you reduce your mortgage repayments?

Whether you’re about to buy a property or are paying off a loan, there are several ways to keep your mortgage payments as low as possible.

1. Buy a cheaper house

It may sound simple, and it’s often easier said than done, but if you’re looking to lower your repayments, the easiest way to do this is to buy a property that meets your needs at the lowest price. as low as possible.

While it may be tempting to borrow up to the limit offered by your lender, that doesn’t mean you should buy a home at that price.

2. Enter the lowest possible rate

It doesn’t matter if you’re applying for your first loan or looking to get a better deal on your existing loan, finding a low-cost home with a competitive interest rate will be key to limiting your repayments.

After all, even a relatively small rate difference could cost or save you tens of thousands of dollars over the life of a typical loan.

“I think everyone should review their rate at least every two years,” says Lees. “Definitely consider renegotiating first because banks want to keep customers and they keep increasing the maximum discount they offer, but don’t be afraid to compare what’s out there and see if it’s worth it. to change.”

3. Make the Most of a Clearing Account

Not all loans come with a clearing account and some lenders will charge you for the privilege of having one, but storing any extra savings you have in a clearing account could be a great way to reduce your regular repayments while having easy access to it. silver.

“Funds inside the clearing account are used to offset the amount owed on your loan, so borrowers will only be charged interest on the difference,” Haupt explains.

“It offers mortgage owners the option of reducing the interest payable for the current period without having to commit the entire funds as a lump sum repayment to the loan.”

Contact us if you are having trouble making your refunds

While maintaining your mortgage payments can be a great goal, rising interest rates are making it harder for almost all borrowers today. In fact, the average monthly repayment has already increased by $610 since April, according to Finder research.

If you’re in a situation where you’re starting to experience mortgage stress and are having trouble making your repayments, Lees recommends contacting your lender as soon as possible.

“If people are having difficulty, it is better to go ahead and talk to their bank because all banks have provisions in case of difficulties.

“You can go to the bank and ask for some sort of relief. Normally they will only offer you interest payments until your circumstances change, even on your owner-occupied property.”

For more information on the difficulties and some strategies you can potentially use, check out our article on what to do if you can’t afford to pay off your home loan.

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