How much of your income should you spend on your mortgage?
Property prices may have started to retreat from their recent highs, but there's no denying that purchasing a home has become a more and more expensive undertaking in recent years.
In fact, since June 2020, the average Australian mortgage has jumped by roughly 25% to over $600,000 according to figures from the Australian Bureau of Statistics.
Until recently, historically low interest rates have helped keep mortgage repayments manageable for most borrowers though - even those with sizeable loans. But that's starting to change thanks to four consecutive cash rate hikes which have quickly flowed through to home loan rates.
As a result, prospective homeowners are now facing both relatively high property prices and rising interest rates, which prompts the question: how much should you be paying on your mortgage?
Ultimately there's no hard and fast rule, so it's going to come down to what you can afford and what your lender assesses that you can pay. Having said that, here are some indicators worth keeping in mind.
The 30% rule and mortgage stress
One of the more common numbers that crops up in the conversation around mortgage costs is 30% - that is, your housing expenses (whether that's rent, mortgage repayments or other related costs) shouldn't exceed 30% of your household income.
Following that idea, if your household income was $7500 each month you would want to ensure that your monthly mortgage repayments were no more than $2250.
Now 30% may seem like a bit of an arbitrary figure, but it actually marks the boundary between what is, and isn't, considered mortgage stress.
For instance, the Australian Housing and Urban Research Institute (AHURI) says that housing stress starts to occur when a household which has an income in the bottom 40% of income distribution pays more than 30% of that income toward housing-related costs.
Of course, that's not to say that a high-income earner would want to put, say, 50% of their income towards housing costs, especially when income can change over the life of a 25-year loan. But neither is it necessarily bad to put more than 30% of your income towards repayments if you're comfortable with it, or perhaps even looking to pay off the loan faster.
Why your debt-to-income ratio matters
Another indicator, and one that is actively used by banks and lenders during the home loan assessment process, is the debt-to-income (DTI) ratio.
"Lenders take into consideration your income versus how much debt you have and will need to be confident that you're in a comfortable financial position overall," says Brodie Haupt, CEO and co-founder of digital lending and payments provider WLTH.
"They generally view borrowers with a smaller debt-to-income ratio as less risky and are more likely to approve their loan or offer discounted rates. Applicants with a high debt-to-income ratio are often subject to more stringent borrowing capacity restraints and may be required to have a larger deposit."
Here's an example. Say your household income is $150,000 and you're looking to take out a $600,000 mortgage, but you also have a $15,000 car loan and $2000 worth of credit card debt. Your total debt ($617,000) would be divided by your income ($150,000) to give you a debt-to-income ratio of 4.1.
But how would that that 4.1 figure actually stack up? Regulator APRA has recently indicated to lenders that it considers a ratio higher than six to be more risky at present given that incomes are unlikely to keep up with housing costs in the short-term.
While each lender has slightly different thresholds when it comes to assessing a borrower's debt-to-income ratio explains Rob Lees, the principal of Mortgage Choice Blaxland, Penrith and Glenmore Park, there is a rough point when borrowers will start to find it harder to get approved.
"Generally speaking, if your debt is less than seven times your income it will normally be okay," he says.
"It's once you start getting above a DTI of seven that it might become problematic. For example, if it's over seven, they may not approve the loan if the LVR is over 80% and there's mortgage insurance involved."
How can you bring your mortgage repayments down?
Whether you're about to purchase a property or you're in the middle of paying off a loan, there are a few ways to keep your mortgage repayments as low as possible.
1. Buy a cheaper home
It may sound straightforward, and it is often easier said than done, but if you're looking to keep your repayments down then the easiest way to do that is by purchasing a property that fits your needs for the lowest price possible.
While it may be tempting to borrow right up to the limit you're offered by your lender, that doesn't mean you have to buy a home with that price tag.
2. Grab the lowest rate possible
It doesn't matter if you're applying for your first loan or looking to get a better deal on your existing loan, nabbing a low cost home with a competitive interest rate is going to be key in keeping your repayments down.
After all, even a relatively small difference in rates could cost or save you tens of thousands of dollars over the life of a typical loan.
"I think everyone needs to revisit their rate at least every two years," says Lees. "Definitely look to renegotiate first because the banks want to keep customers and they keep increasing the maximum discount that they're offering, but don't be afraid to compare what's out there and see if it's worth changing."
3. Make the most of an offset account
Not all loans come with an offset account and some lenders will charge you for the privilege of having one, but stashing away any additional savings you have into an offset account could be a great way of reducing your regular repayments while still having easy access to that money.
"Funds inside the offset account are used to offset the amount owing on your loan, so borrowers will only be charged interest on the difference," explains Haupt.
"It provides mortgage owners with flexibility to reduce the interest payable for the current period without having to fully commit the funds as a lump sum repayment into the loan."
Reach out if you're struggling to make your repayments
While keeping your mortgage repayments down can be a great objective, rising interest rates is making that task more difficult for almost all borrowers at present. In fact, the average monthly repayment has already increased by $610 since April, research from Finder shows.
If you are in a position where you're starting to experience mortgage stress and you're having trouble making your repayments, Lees recommends reaching out to your lender as soon as possible.
"If people are experiencing hardship, it's better to get on the front foot and talk to their bank because all banks have hardship provisions.
"You can go to the bank and ask for some sort of relief and normally they will offer interest-only payments until your circumstances change, even on your owner-occupied property."
For more hardship information, and some strategies you can potentially employ, check out our article on what to do if you can't afford your home loan repayments.
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