Applying for a mortgage is about showing the bank three things: you have enough income to pay for the mortgage, you have enough deposit to keep the bank happy and, finally, you are responsible with your money.
It’s that last point that applicants often forget and banks are beginning to look in-depth at a client’s financial "character". Almost all banks are categorising the last three months of expenses (much like Xero does for businesses). If you’re spending more than they’re comfortable, they reserve the right to reduce the amount you can borrow or even decline you.
One trick we sometimes use with first home buyers is to get them to run a mock mortgage. In other words, pretend they are paying a mortgage. Not only that, pretend they are paying it at a seven percent interest rate.
If you’re expecting to borrow $500,000 for your first home, you could expect to pay $767 per week (based over 30 years at seven percent). The trick to a mock-mortgage is putting the difference between your current rent and your future mortgage into a savings account. If you are currently paying $400 per week in rent and calculated $767 per week for your mortgage, you need to put $367 per week into a savings account.
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A lot of people will have noticed that the interest rate is significantly higher than the current interest rate. You’re calculating a mortgage at seven percent when interest rates are far below three percent. But the banks calculate your ability to afford a mortgage at seven percent when they’re assessing your application. It’s not that they think interest rates are going to go to that high any time soon; they just need to assume the worst. In other words, they need to know that, if interest rates begin to rise, you will still be able to afford your payments.
Giving the bank at least three months of bank statements showing that you’re already paying the mortgage is a winning strategy. And an unexpected additional benefit is that once you actually get the mortgage, you’ll be used to much higher payments. The $500,000 mortgage above will be paid off in just over 15 years (not 30) if you fix it at today’s 2.65 percent but lock in payments at the higher $767 per week. Unbelievably that will also save you over $500,000 in interest!
One last rule for a mock mortgage: don’t dip into your savings account. The bank needs to know you can afford the future mortgage and taking money out of that savings account tells them you can’t live with those payments.
With Covid-19, tens of thousands of people have recently been made redundant or are struggling with their business.
Buying a home will feel unachievable at the moment. If this is you, don’t beat yourself up because you can’t afford a mortgage at seven percent. Just calculate what interest rate you could afford today for your first home.
Let’s say today, you could pay a $500,000 mortgage if it was locked in at 2.5 percent ($456 per week). But when you go back to full-time hours or your partner finds work, you’re going to increase that to seven percent - or maybe just five percent while you find another job. It’s absolutely fine to not be able to pay seven percent on your mortgage today as long as, when you do increase your income, you put it towards savings not unnecessary items.
- Rupert Gough is the founder and CEO of Mortgage Lab and author of The Successful First Home Buyer.
