Technically speaking, if more than 30 percent of your pre-tax income goes towards paying your mortgage, you meet the common definition for being ‘mortgage-stressed’ – and it’s more common than you think!
When thirty-something professionals Harry and Sally were house hunting for their first home they were on high incomes and had saved a healthy deposit. Even so, they cautiously did their homework, entering their information into several bank online calculators to determine their borrowing capacity.
They entered:
| Borrower | Couple |
| Dependents | 1 |
| Reason | Residence |
| Pre-tax salary | $190,000 annually |
| Living expenses | $4,000 monthly |
| Current loan repayments | $0.00 |
| Personal loan repayments | $600 monthly |
| Credit card limits | $15,000 |
How much?
The highest amount suggested by one of these calculators was around $976,000 with monthly repayments of $4,650 over 30 years. Based on their current combined income this would take up 29.3% of their pre-tax income.
It’s natural to want the best home affordable. “We’re on good money. We figured we could afford it,” Harry said during our first meeting.
“But it’s a lot of money to owe,” Sally added as she started to understand what other costs might be involved. “A larger house costs more to maintain and furnish; plus higher council rates.”
When inflation is low and wage growth is next-to-nothing, households with large mortgages could be in real strife when costs of living go up or interest rates rise – regardless of the Reserve Bank of Australia’s (RBA’s) management of the cash rate. Already banks are increasing the rates on home loans off their own bats.
Online calculators generally use limited information to give applicants an idea of what might be available to them. Supporting a mortgage up to thirty years requires more detailed consideration than credit card limits and pre-tax earnings.
The banks’ calculations would take Harry and Sally perilously close to the 30 percent threshold. Increased living expenses, or small interest rate rises would tip them into the danger zone.
Together we looked at an independent mortgage calculator on the ASIC MoneySmart website at www.moneysmart.gov.au. By working on the couple’s AFTER tax income of $140,536 [1] and applying 25% of this to calculate monthly repayments of $3,000, MoneySmart’s calculator returned a more realistic estimate of $629,000 [2].
Though disappointed, they pragmatically decided to continue growing their deposit and even looked at ways of increasing their saving potential.
Options for increasing a loan deposit
Harry’s friend is saving for a home deposit by being a ‘house-sitter’. Initially popular for grey nomads, house-sitting has become a growing trend for potential home-buyers to live rent-free in exchange for caring for pets and plants. While this sounds idyllic, the nomadic lifestyle doesn’t suit everyone, and Harry’s friend occasionally ends up on his mum’s couch between sitting engagements. With a small child, this was not an option for this couple.
Alternatively, they could rent their spare room to Sally’s niece studying at a nearby university. That appeared more workable, not to mention a free baby-sitter!
And managing risk
Finally, we talked about insurance. It’s imperative that the couple’s income – their most valuable asset – be protected. Additionally, life cover, to provide for their daughter should anything happen to either of them was vital.
Unfortunately, too many people are in over their heads. If you’re experiencing mortgage-stress or you’re losing sleep worrying about an interest rate rise, speak with your licensed adviser about a strategy to relieve the pressure.
[1] $100,000 + $90,000pa = $190,000pa combined income after tax and Medicare levy.
[2] Calculated at 3.99% interest over 30 years, not including fees or charges.