Understanding your budget is one of the key steps on your property journey and one of the first things you need to work on.
Budgeting allows you to measure your discretionary and non-discretionary spending.
Discretionary expenses includes all non-essential spending such as eating out and entertainment.
Non-discretionary includes groceries, electricity, rent or mortgage repayments.
It is important to review both to see where savings can be made. Eating out less often and finding a better deal by switching Internet providers can help you save more and boost your borrowing capacity.
Your budget reveals your current financial position which is used to determine your borrowing capacity.
Knowing your borrowing capacity narrows down your options to what you can comfortably afford.
Basically, you need to know how much the bank will be willing to lend you before you can go searching for a property.
Your borrowing capacity goes beyond saving for the initial deposit. It needs to demonstrate you can cover mortgage repayments, living expenses and other debt obligations, such as car loans, credit cards, etc.
Tip: Credit cards, car novated leases, car loans and personal loans are considered by the lender in their assessment and they can drastically reduce your borrowing capacity.
For example, a $5000 credit card can reduce your borrowing capacity by as much as $30,000.
It doesn’t matter if you are paying the balance at the end of each month.
Banks will work on the assumption that you can max out the card and only pay the minimum monthly repayment.
To maximise your borrowing capacity, try to get rid of credit cards and loans where possible.
Borrowing Capacity
Your borrowing capacity is determined by:
- Income: Your regular income as well as other sources such as allowances, bonuses, commissions, overtime, rental income and government payments.
- Expenses: Your daily living expenses such as bills, electricity, groceries, fuel and other ongoing financial commitments.
- Debts: Credit cards, car and personal loans.
- Credit score: Your credit score is based on your history of borrowing and repayments.
- Assets: Property, savings and shares.
The above are used to determine your Debt Service Ratio (DSR) which is income divided expenses. The lower, the better and a DSR over 30% can be an indicator of financial stress.
While banks and lenders vary as to how they work out how much they will be willing to lend, you need to complete your own budget to see how much you can comfortably dedicate to loan repayments.
Your borrowing capacity determines what you can buy and where. unless you have an unlimited budget, you will have to make compromises in what you can purchase.
The compromises are price, property or location. You may have to pay more than you thought for the property you’re after. If a higher price point is not an option, you may have buy an older or smaller property. Lastly, you may not be able to buy in your location of choice and need to look in the next suburb or further.
Mortgage Broker Vs Bank
A mortgage broker is an intermediary between borrowers and banks. They help borrowers find and secure the most suitable and favourable loan.
We generally recommend borrowers go with a mortgage broker rather than dealing with a lender. This is because they offer a customer-centric service, provide access to a wider range of loan products, personalised guidance and potentially favourable rates and terms.
Mortgage brokers are typically paid by commission from the banks upon successfully referring a borrower to them, and usually do not charge their clients.
Of course you do not have to use a broker. You can go to the bank yourself or search the home loan market to see what is available. While brokers typically work with a panel of lenders, they do not have access to all of them. This may give you an advantage but you do need to do the leg work yourself.
Your individual circumstances will vary and depending on your credit score, income, deposit amount and personal preferences, so you may opt to deal with a lender directly.
Mortgage Broker Checklist
If you do decide to go with a mortgage broker, it usually best to seek out recommendations. Not all brokers are the same and you should be able to gauge a broker by asking some questions:
- Are they are licensed to provide loan advice? Ask for their license details or check the ASIC Connect Professional Register website. Search Credit Representative or Credit Licensee.
- How are they paid? Find out if they charge a fee or get paid by commission. If they are paid by commission, ask if this varies by lender.
- Do they work with various lenders? A broker that works with only one lender is a salesperson, not an independent professional working for you.
- Their recommendations should be based on your requirements now and in future, so they should start by understanding your current circumstances and your goals in the future. How can they help you?
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