How much can you afford to pay on your home loan?

Rates and Fees verified correct on December 11th, 2016

Work out how much you can afford to put towards your home loan so you have enough money to live comfortably.

Income is one of the most important factors when applying for and paying off a home loan. Potential lenders will want to know you earn enough money to be able to pay off your home loan, not only at the advertised rate, but often at rates up to 1% higher. This reduces the risk that the bank takes on by offering you a home loan.

Having enough money to weather the storm of rising repayments or unexpected costs is the key to having a comfortable financial life. Here’s how you can find out how much you can truly afford to put towards your mortgage.

Find out how much you need

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The loan amount you are approved for will depend on a few things, such as the value of the property you wish to purchase, you and your partner’s income, your debts and assets, and your financial history. While you may want to borrow a certain amount, it’s up to your lender to approve you for that amount. It’s important to work out an amount that you would be comfortable paying back on your budget, and an amount that will let you buy the home that you want.

Finding out how much you need to borrow depends on factors like how much you wish to spend when buying a home, how much you qualify to borrow, whether you're eligible for stamp duty concessions or the first home buyers grant, and how much you have to pay in the form of taxes, fees, and charges.

While certain lenders offer home loans of up to 95% of a property's value, in such a scenario you'd have to pay for lenders' mortgage insurance (LMI). Ideally, you should cover around 20% of the purchase price on your own, and get a loan for the remainder. This enables you to avoid the LMI premium and means you can also build equity sooner and lowers your repayments.

Assess your financial capacity

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Your income has a direct bearing on how much you can borrow to buy a home, but some people have little understanding of how a lender will view their financial capacity when they apply. You can find out what repayments you'd be looking at for any given amount by using a mortgage calculator. Keep in mind that your monthly repayments are recommended to be less than a third of your monthly income.

When lenders look at home loan applications they take several aspects into account, some of which include your annual income, your monthly expenses (including dependent children), estimated repayments, the type of loan you're applying loan, as well as repayment type. Your ability to make repayments through the term of the loan remains crucial even at the application stage, so ensure you’re in a secure financial position.

Lenders also look at assets and liabilities to assess an applicant's financial capacity. Your liabilities include outstanding balances of credit cards, personal loans, and car loans. Assets can include vehicles, jewellery, furniture, savings, and investments. Your occupation and your employment history can also have an effect on how much you can borrow.

Assessing your financial capacity requires that you take your lifestyle into account. While some people have no qualms in making sacrifices to own a home, others would rather live a carefree life than restrict themselves with high repayments. You will need to weigh up your financial commitments and see if you will need to, and be willing to, make adjustments to your lifestyle to be able to make your repayments.

You can also use our borrowing power calculator below to get an estimate of how much you might be able to borrow.

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How to identify your other financial obligations

When you decide to apply for a home loan, identifying your other financial obligations is important, as you could get into trouble if you fail to do so. Take into account all your monthly expenses and make note of all expenses that are recurring in nature. These include phone bills, electricity bills, gas bills, and credit card bills, as well as money you spend on your dependent children, travelling, groceries, clothes, entertainment, memberships, and eating out. You also have to account for any personal, student, or car loans, as well as insurance and healthcare-related costs.

Once you know of your financial obligations, identify if you can eliminate any, but make sure you don't end up over-stretching. What this means is that you should look at your current patterns of spending and saving, and think realistically at ways that you might be able to cut back, because trying to cut back too much could cause you to allocate less money to an expense than is needed in reality.

Looking at saving money is also a good option, especially if you're not inclined to do so, because savings get you through any emergency situations that might arise. Reducing your financial obligations before you apply for a home loan might also be a way to get in a better financial position, and a good way to start is by minimising your overall debt.

Set up a budget

Setting a budget enables you to pinpoint exactly where your money is going, it tells you where you can save, and it also may indicate how much you can afford in the form of home loan repayments. This figure should ideally guide you in how much you could borrow, as opposed to going with how much you qualify to borrow.

While an effective budget is one that delves into details, it should also give you room to deal with unexpected expenses. For instance, you might want to renovate your home's kitchen or bathroom, the interest rate on your home loan might increase, or you might want to buy a second car for your partner. In fact, it’s always a good idea to see what your budget would look like if rates increased by 1% and even 2%. This will help you work out if you could deal with interest rate hikes.

A good budget should allow you to view your earnings and expenses in different sections while also comparing them, it should allow you to set budgeting targets and track them easily, it should track your savings, and it should also forecast where your savings are headed. Boosting your savings should be an integral part of your budgeting, and this is to deal with any unexpected incident.

Use a mortgage calculator

Using a mortgage calculator gives you the ability to find out what repayments any given loan amount can attract. In addition to the amount you wish to borrow, a mortgage calculator also takes into account the loan term, the interest rate, repayment frequency, and monthly fees. For example, if you borrow $250,000 at a fixed rate of 10% p.a. and you plan to make monthly repayments over the next 25 years, you can expect to pay around $2,450 as your monthly repayment. Longer loan terms result in lower repayments, but you would also end up paying more in the form of interest.

Use our mortgage repayment calculator.

Choosing the right home loan is the first step to helping you save some money in the long run. Before you apply for a home loan it is important that you establish how much you can afford to repay on an ongoing basis, because if you don't make timely repayments you could end up paying much more than you expected.

Marc Terrano

A passionate publisher who loves to tell a story. Learning and teaching personal finance is his main lot at finder.com.au. Talk to him to find out more about home loans.

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