5 money tests to pass before getting your first mortgage
You may be emotionally ready to settle down but how do you know you are financially ready to buy your first home? Taking on a mortgage is one of the biggest financial decisions you’ll ever make, so before you take the plunge it’s a good idea to take a moment to consider all the expenses attached to owning your first home.
Here are 5 tests Mozo’s money gurus say first home buyers should pass before taking out a mortgage. And if you don’t, it could be a sign you’re not quite (financially) ready to buy.
# 1. Have a budget and you know how to use it
Good money management skills are a must-have for first time home buyers as there are a host of new expenses you’ll need to prepare yourself for like council rates, water bills and home insurance. And for the first time, you’ll be responsible for the upkeep of all appliances, the water heater, yard and building maintenance so you need to make sure that you can cover the costs (in addition to your mortgage) if things need to be repaired.
If you aren’t already sticking to a household budget, now is the time to start one.
#2. Know how much you can borrow
Everyone wants to live in the house of their dreams but when you are considering home ownership it’s important to not only think about what you can afford now, but also put some thought into the future of the property.
Will you be buying as a couple or as a single? If you are borrowing as a couple you might be able to make high repayments while both of you are working but what happens if one of you stops working to go back to uni or you start a family?
If your current job isn’t enough to pay for the type of property you, consider looking for a new position. However, keep in mind that lenders look at the length of your employment. A full-time job that pays well is favoured by lenders than part-time or casual work. If you are a part-time or casual worker it doesn’t mean you’ll never get approved for a home loan, it will just be more difficult.
Once you know how much money the banks will lend you, you can start narrowing down the types of properties and suburbs that you will be able to afford to purchase in.
#3 Have the requisite deposit
The advised deposit required is generally 20% of the property price. That means for a $500,000 apartment you will need $100,000 upfront.
Some lenders will let first time buyers borrow up to 95% of the property value but anything over 80% means that you’ll need to pay LMI, which can be as much as 3% of the loan amount. The cost of this insurance gets added to your home loan and protects the lender if you forfeit or default on your home loan. LMI also isn’t transferable so until you have an LVR (Loan-to-value-ratio) of less than 80% you will have to pay this insurance again if you buy a new property or switch loans.
The benefit of having a bigger deposit is that you’ll have more equity in your home from the get go. Generally in the early years of a home loan, the bulk of your repayments are going towards interest and a smaller amount towards the principal. So the more equity you have upfront, if you need to sell or access funds in an emergency you have greater flexibility.
#4. Be able to handle repayments
Now that you’ve got an understanding of the amount of money you can borrow, it’s time to road test those repayments. While you’re probably already forking out money for rent, remember that home loan repayments are likely to be higher especially when you factor in other expenses like insurance and maintenance.
To prepare yourself for the reality of home ownership run a full mock budget for 6 months based on your estimated repayment amount. Set up an automatic transfer of the estimated monthly mortgage repayment amount (minus your rent) from your bank account and put it into a high interest savings account.
Ex. Your monthly rent is $1,600 and your hypothetical mortgage repayment is $2,400 plus $600 in insurance and maintenance expenses.
3,000 (mortgage + extra bits) – 1,600 (current rent) = 1,400
You should be able to put aside $1,400 into a savings account without it affecting your lifestyle. If putting that extra $1,400 aside during the six month mock budget is too difficult you might have to reconsider how much you can actually afford to borrow.
Buying a home is a long term commitment so it is better to find out if your budget has any breaking points prior to buying, instead of ending up with a mortgage you can’t afford or living a lifestyle you’re not happy with.
#5. Be prepared to withstand rate hikes
While interest rates are at record lows, economists predict a rate rise in the near future, so it’s a wise idea to always have room in your budget for a market movement.
Would you still be able to afford the repayments if rates rose by 1%? What would you need to cut back on?
Try upping your repayments to the new amount for a set period to see if it’s something you can do easily or will struggle with.
The good news is that you’ll save yourself a nice emergency fund if rates don’t rise and be fully prepared if they do.
Source: Maria Gil
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