Whilst your lender will determine the maximum amount of money they would be willing to lend you (based on your ability to afford minimum repayments over a 30 year term); savvy borrowers calculate their own limits and know themselves what they can afford. By calculating and planning to set your own limits, you will be in control of your own home loan, you will choose the most suitable loan for you, and you will achieve the greatest value in a loan.
How much can you really afford to repay?
The limits that you establish for yourself can be determined by knowing how much you can repay per week, fortnight or month. Look at your income and determine how much of your income you can afford to put towards your home loan on a regular basis.
But before we get started answer this question.
How often do you get paid, or if you are buying with someone and they are the regular income earner, how often do they get paid? Is it every:
- week;
- fortnight; or
- month?
How often you get paid determines when you will be making repayments. From here on in, when you are asked to calculate something use the answer you just gave. If you get paid weekly, work out your repayments etc on a weekly basis; if you get paid fortnightly or monthly, use that to work out your repayments.
Next you might be wondering, how much should I be paying towards my home loan?
There are just two more important questions we have to answer before we can answer that question.
- How much do you earn?
Only you know how much you earn on a regular basis. If you do not always earn the same amount, base it on the minimum you earn on a regular basis. Bear in mind when you do apply for a home loan, your lender will always ask you for your last two or three most recent payslips (and they have to be consecutive—if you get paid weekly, they have to be from the last two or three weeks; if you get paid fortnightly, they have to be from the last two or three fortnights; if you get paid monthly, they have to be from the last 2 or 3 months—we learned this the hard way with my casual wage when I did not have consecutive payslips—I’ll tell you about that later). When you apply for a home loan, you must be able to provide evidence that your earnings are what you say they are for two or three consecutive payslips in a row.
How much do you earn (after you pay tax) and how often do you get paid? Write that down somewhere.
- How much are your future expenses?
Household bills can put a big dent into your home loan repayments so you need to work out how much that will be before you commit to your repayment amount.
We were renting at the time we purchased so we already had the usual household bills and could account for those extra future costs already. The only extra regular payment we would have to make was purchasing our home and contents insurance each year.
If you are lucky enough not to be paying household bills, working out your future bills could come as a nasty shock.
Some of the most common regular household bills are:
- Grocery bills
- Home and contents insurance
- Electricity
- Gas
- Water Rates
- Council Rates
- Internet and/or home phone bills
- Mobile or mobile data bills
- Car registration, servicing fees, car insurance and associated car running and maintenance costs
- Strata[1] (if you purchase an apartment, townhouse, villa, or a home in a community estate)
- Land tax[2] (if applicable)
- Property maintenance costs
You may even have other household bills I have not listed here (e.g., television subscriptions, gym memberships, retail shopping, holidays, entertainment, eating out, school fees, fees for kids activities or childcare).
Whatever bills you have or are about to have, you need to estimate what these could be as they will eat into your home loan repayments. Do this before committing to a repayment amount. I have not estimated the cost of household bills in this book as they are different for everyone.
To quickly work out how much your bills will cost per week, fortnight or month, download the ‘Pay my bills’ worksheet (payitinfive.com/gifts) using code 1234 to estimate your bills per week, fortnight, month or even year.
Work it out so that it is has the same timing as you get paid (e.g., per week, fortnight or month). Then write that amount somewhere:
How much are your future bills?
How much can I repay regularly?
Now for the all important question: how much can you repay regularly?
Maybe you already know this.
If you used the ‘Pay my bills’ calculator, congratulations, you have just worked this out. If not, you can do that now or work it out yourself.
In general, the banks may determine the amount of money you can borrow based on repayments of around 30% (or lower) of your main source of income. However, if you would really like to get ahead faster, you should aim to make repayments based on somewhere between 30 and 50% of your income (depending on your income and expenses) that you can pay off on a regular basis (i.e, per week, fortnight or month) in a short amount of time (e.g., five to ten years).
To work out how much you can repay regularly, work out what your income is (after you’ve paid tax) and minus your expenses (note, both the earning and expenses should either be per week, fortnight or month). Now you have an estimate of how much you could potentially put towards your home loan (savings) or other expenses.
To work this out as a percentage of your income, take your savings amount and divide this by your income (after tax is paid). Again, stay in the same category for weekly, fortnightly or monthly to work this out.
For example, Borrower A plans to repay $700 per week towards their home loan and they earn $1,200 per week.
As a percentage this is: Repayment / Income = percentage of income going towards home loan.
For Borrower A, this works out to be around 66% of their income going towards their home loan (that is, $700 divided by $1,200). They know that some weeks they may only be able to repay $600 (50%), and in other weeks they may be able to repay up to $900 (75%); but in general, they are confident and feel comfortable that they will be able to repay $700 per week on their home loan the majority of the time.
Your situation may be different and you may only be able to pay 30% of your income to your home loan repayments the majority of the time (e.g., maybe you have a lot of bills or expenses).
Only you can determine how much you can afford to repay. Use our free ‘Pay my bills’ calculator (payitinfive.com/gifts) to work this out for you.
If you know how much you can afford to repay per week, fortnight or month, write down that amount somewhere and how often you can repay this.
What if I still don’t know how much I can afford to repay?
If you are still not sure how much you can afford to repay, look at the last three months of your bank statements (or the last year if you can). How much have you saved in the last 3 months (or year)? This can give you an indication of how much you can repay.
For example, if you earned $12,000 in the last three months and you spent $6,000, you will have saved $6,000 in three months. This leaves you with an approximate repayment amount that you may be able to repay per quarter.
To work out for yourself how much you can comfortably repay on a monthly basis, divide the amount you saved in three months by three. For example, $6,000/3 = $2,000 per month.
Note, if you only worked this out based on three months, this is a very rough estimate only as you may not have taken into account bills that only happen every year, or bills you will receive when you buy a property. So be careful if you are estimating at this cost and if it is based on three months as it is only a rough estimate. To make this estimate more accurate, use our free ‘Pay My Bills’ calculator at payitinfive.com/gifts.
Then write down that amount somewhere and how often you can repay this.
[1] A note on Strata, Strata is an extra repayment you make on some properties (e.g., an apartment, community estate, townhouse). Our first property had strata. After we already had the loan I worked out the extra repayment for strata to be like borrowing an extra $100,000 (because the strata amount was like the interest we paid on a home loan at the time). If you are looking at properties with strata, would you rather to pay that strata, or would you rather have a bigger loan that matches those strata bills? For us, it was still better to buy the cheaper house with strata bills as it meant we could pay our home loan off faster. But it’s your call. You would indeed still need to pay off the additional loan amount too if you borrow more instead.
[2] A note on land tax. Land tax in Australia is paid when the value of the land is greater than an amount set by the government. If you are buying a cheap first home, it is unlikely that you will pay land tax. However, since land tax changes so much over time, this book will not cover this issue. You need to work out if that will impact you (do a search on internet to find out if this impacts you). For us, this wasn’t something we had to worry about on our first home.