So with $100,000 we can afford to buy a $400,000 property. But can we make the mortgage payments? Looking at a home loan comparison rate finder on the internet I can see the lowest three year fixed rate home loan rate is currently 4.69% (June 2014), which would make our monthly payments $1,250.  But can we afford this?

Regardless of how much the financial provider will lend you, you need to do your own calculations to work out realistically and comfortably how much you can borrow. I remember when I was asking for mortgage pre-approval five years ago the bank was willing to lend me close to $1million!! Believe me, I could NOT have afforded this AND been able to buy bread and milk each week!

FIRSTLY you need to work out your income and expenses. The simplest way to do this is get all of your bank and credit card statements for the last 3-6 months and identify all of your (and partner’s if relevant) net income (post tax and super) and expenses. Being the geek I am I like to put this in a spreadsheet & categorise it. Remove any non-recurring items but make sure you include big annual expenses such as holidays and insurance policies and income such as bonuses. If the property will be your new home, deduct any rent or mortgage payments as these will not continue. Let’s assume we’re doing this analysis for a monthly basis.

Income:
$ 3,750           Salary (net after tax & super)
$      50           Share dividends
$    300           Interest
$ 4,100          Total Income

Expenses:
$    300           Utilities
$    350           Food (at home)
$    500           Entertainment: eating out, alcohol, movies, etc
$    150           Mobile phone, travel to work, magazines
$    400           Car payments, petrol, servicing, insurance, etc
$    300           Clothes
$    300           Holidays
$    400           Insurance: home & contents, health, etc
$    200           Personal care
$    100          Gifts
$ 3,000          Total Expenses

Net income per average month $1,100

This exercise is very simple if a bit tedious, but unbelievably eye-opening too. If you categorise your expenses and calculate the percentage of each category against the total, sometimes you might be frightened how much you spend on gifts, going out, travel etc. It’s also a good exercise to do if you want to save money.

SECONDLY you need to forecast your short to medium term financial position. Consider the timeframe that you would consider fixing the mortgage for (typically 3-5 years). This is incredibly important because if your circumstances change, you need to still be able to comfortably pay the mortgage. Some things to consider…

• Income increasing – For example, if you have your own business and it is in the growth phase, or you expect a pay increase from work. This is a tricky one and being the conservative I am, tend to approach this type of forecasting with caution,
• Income decreasing – For example, what are the chances of being made redundant? Is there a seasonal downturn in your earnings? Will one of you be going on maternity/paternity leave soon?,
• Expenses increasing – For example, will I start having children, or for those parents out there, another child? Are you buying a new car? Going to start studying again?,
• Expenses decreasing – For example, will repayment of HECS debt or any other loans or credit cards be ending soon?

Adjust your average monthly income and expenses for these future events and you end up with the net amount available to pay a mortgage. If you also want to save money in addition to paying your mortgage then adjust this further.

LASTLY, using a simple calculation we can work out the mortgage payments you can comfortably make each month:     (monthly net income X 12 mths)  /   annual mortgage rate %

In this example:                                                                                        (1,100 X 12)    /    4.69%     = $281,000 mortgage

Therefore this tells us that even though we have saved $100,000 (well done!!) and we can afford to buy a $400,000 property (with a $320,000 mortgage), we actually can only afford a $281,000 mortgage. So using our LVR of 80% this means we can only really afford a $350,000 property. Again, by thinking “well I’m ready to go with my $100,000, that’s my 20% deposit for a $500,000 property”, you not only need to look at the total CASH OUTLAY when buying a property but also your NET INCOME to see what mortgage you can really afford.

Up next… 3. What is my risk appetite regarding fixed versus variable mortgages?