Deciding how much you can spend on your home loan is very important. It is tempting to look at whether you can afford a property based on the old system of a maximum mortgage being three or three and a half times your salary and to be swayed by the perfect house, but this might not be a good way to decide.
Debt to Expense Ratio
Modern mortgage lenders generally cap lending at twelve and a half times your annual salary, but they will also look at your monthly costs, any additional income and any changes in the future, when they assess whether you can afford it.
This is a good system and it’s a good idea to use a similar system yourself. The generally agreed rule of thumb is that your home loan payments should make up no more than 28% of your gross (pre-tax) income. That makes sure that you can still eat, go on holiday, pay for insurance, and cover all of the other expenses you will have.
The home loan interest rates are incredibly low at the moment. When you decide how much a month you can spend on the home loan, you need to bear in mind that at some point they might go up again, as the saying goes ‘what goes down must come up’! There are different mortgage products available, with different interest rates, but it is almost inevitable that they will all go up to some extent!
You need to consider how much you currently spend a month. If you have a lovely new dream home, but do not have enough money left (after the mortgage is paid) to continue with your hobbies or fund your car, you will soon regret buying that house.
Monthly Home Budget
A good way to decide how much you can spend on your mortgage each month, is to look at the spending costs of the house. A bit like looking at running costs for a car, rather than only looking at the purchase cost of the car. You must consider property tax, insurance, heating/cooling, lighting and water, as well as transport costs (are you nearer work, will the school run be shorter?). This is particularly useful if you are looking at moving to a bigger property where the costs may be more or if you are moving into a different area. If the house needs some repairs or redecorating you need to factor the costs of the repairs, especially if the repairs are essential; heating or roofing, for example.
Consider the changes to your life in the future, are you planning a family? Will you have kids leaving home? Are you approaching a big milestone that will need some money? Some things are hard to predict, but it is important to have a good idea!
When you decide how much to spend a month on your home loan consider the costs of running the house and your current (non mortgage) spending. Then consider the future costs you may have and any additional costs of renovations. Lastly, remember to allow for rise in interest rate!