5 money tests to pass before getting your first mortgage
You may be emotionally ready to settle down but how do you know you are financially ready to buy your first home? Taking on a mortgage is one of the biggest financial decisions you’ll ever make, so before you take the plunge it’s a good idea to take a moment to consider all the expenses attached to owning your first home.
Here are 5 tests Mozo’s money gurus say first home buyers should pass before taking out a mortgage. And if you don’t, it could be a sign you’re not quite (financially) ready to buy.
# 1. You have a budget and you know how to use it test
Good money management skills are a must-have for first time home buyers as there are a raft of new expenses you’ll need to prepare yourself for like council rates, water rates and home insurance. And for the first time, you’ll be responsible for the upkeep of all appliances, the water heater, yard and building maintenance so you need to make sure that you can cover the costs (in addition to your mortgage) if things need to be repaired.
If you aren’t already sticking to a household budget, now is the time to start one, see here for a template to get you started.
#2. I can afford to borrow ... test
Everyone wants to live in the house of their dreams but when you are considering home ownership it’s important to not only think about what you can afford now, but also put some thought into the future.
Will you be buying as a couple or as a single? If you are borrowing as a couple you might be able to make high repayments while both of you are working but what happens if one of you stops working to go back to uni or you start a family?
To find out how much you can afford to borrow on your income try Mozo’s home loan borrowing calculator.
Once you know how much money the banks will lend you, you can start narrowing down the types of properties and suburbs that you will be able to afford to purchase in.
#3 The sizable deposit test.
The advised deposit required is generally 20% of the property price. That means for a $500,000 apartment you will need $100,000 upfront. Saving up a sizeable deposit can be one of the biggest hurdles for first time buyers but there are ways around this with things like lenders mortgage insurance. Some lenders will let first time buyers borrow up to 95% of the property value but anything over 80% means that you’ll need to pay lenders mortgage insurance, which can be as much as 3% of the loan amount. The cost of this insurance gets added to your home loan and protects the lender if you forfeit on your home loan. Lenders mortgage insurance also isn’t transferable so until you have an LVR (Loan-to-value-ratio) of less than 80% you will have to pay this insurance again if you buy a new property or switch loans.
The benefit of having a bigger deposit is that you’ll have more equity in your home from the get go. Generally in the early years of a home loan, the bulk of your repayments are going towards interest and a smaller amount towards the principal. So the more equity you have upfront, if you need to sell or access funds in an emergency you have greater flexibility.
#4. Repayments roadtest
Now that you’ve got an understanding of the amount of money you can borrow, it’s time to roadtest those repayments. While you’re probably already forking out money for rent, home loan repayments are likely to be higher, especially when you factor in other expenses like insurance and maintenance.
To prepare yourself for the reality of home ownership run a full mock budget for 6 months based on your estimated repayment amount. Set up an automatic transfer of the estimated monthly mortgage repayment amount (minus your rent) from your bank account and put it into a high interest savings account.
Buying a home is a long term commitment so it is better to find out if your budget has breaking points prior to buying, than end up with a mortgage you can’t afford or living a lifestyle you’re not happy with.
#5. Rate rise test
While interest rates are at record lows, economists predict a rate rise in the near future, so it’s a wise idea to always have room in your budget for a market movement.
Would you still be able to afford the repayments if rates rose by 1%? What would you need to cut back on?
To find out how much extra your monthly repayments would be if rates were to rise, see Mozo’s Rate Change Calculator. Try upping your repayments to the new amount for a set period to see if its something you can do easily or will struggle with. The good news is that you’ll save yourself a nice emergency fund if rates don’t rise and be fully prepared if they do.