Obtaining a mortgage and buying a house is an important step in anyone’s financial journey. It’s something that should feel exciting – but for many, it can feel confusing and stressful. According to research, over half of homeowners were made ill by the stress of home buying.
Getting a mortgage is a big commitment. You are going to have a lot of jargon and numbers thrown at you, whether it’s interest rates, fixing periods, capital and interest payments, adjustments and amortization periods, the works. Yes, these are important things to get your head around. But it’s also important to see past them and consider some guiding principles before pulling the trigger on a mortgage.
20% is a useful number when it comes to thinking about mortgages. Provided you have enough money to cover 3-6 months of emergency income, it’s sensible to put down at least 20% of the value of the house your are purchasing in cash. In other words, your mortgage should account for no more than 80% of the total purchase price.
Lots of people struggle to pay their mortgages. They bite off more than they can chew, and wind up having to set aside 50%+ of their monthly net income in mortgage payments.
Experts have long argued that housing costs should represent no more than 30% of a homeowner’s gross monthly income, enabling you to save for a rainy day, put money aside and plan for your retirement and of course, enjoy a decent lifestyle.
It’s important to remember that housing costs go beyond principal and interest based mortgage payments – they also include taxes, insurance, utilities, upkeep and other costs. In fact, banks use this rule of thumb to calculate how much money to lend you. So it makes sense to try to limit your mortgage payments to around 20-25% of your gross income, leaving flex to cover the other running costs that come with home ownership.
Before purchasing a house, you need to consider your wider debt burden in order to figure out what you can afford in terms of mortgage payments.
It’s worth sitting down with a pen and paper (or for those of you who are more organized, a spreadsheet) and listing out your liabilities, including mortgage payments, property taxes, car leases, credit card payments and other short-term debt. Short-term liabilities often carry much higher interest charges than mortgages, and they can quickly stack up.
Calculated as a percentage of your gross monthly income, this is your Total Debt Service ratio (TDS). Your TDS should comprise no more than 40% of your gross monthly income.
Building equity in your home is an important part of securing your financial future. But it doesn’t guarantee that you will be able to retire in comfort. To do that, you need to save and invest in other assets.
Let’s assume you and your partner both earn $50,000 per year and you’re aiming to save 20% of your combined income every month ($1,666). After 20 years of saving (assuming a 6% rate of return), you’d have close to $700,000 in assets. But if you start earlier and save and invest for 40 years, you will have just over $3 million! Such is the power of compounding. Starting early gives you the best possible chance of securing your retirement. Have a play with this calculator to get a feel for the stunning impact that compounding has on saving.
Many people are lucky enough to come into lump sums of money at some stage in their life. It might be a bonus from work, a severance package, an insurance claim or an inheritance from a loved one.
Windfalls present great opportunities to pay down your mortgage and reduce you monthly interest payments, provided that you retain a contingency fund in case you need to rely on savings for 3-6 months. It’s sensible to use windfalls to pay down mortgages whilst interest rates remain low, since if they reset higher in the future and your fixed-rate term has expired, your monthly interest payments will rise. But always pay off debts with high interest rates first, before paying down your mortgage. That way, you will incur less interest charges over time.
A word of advice – before obtaining a mortgage, it’s worth checking the paperwork for conditions regarding early repayment charges. These are designed to prevent you from remortgaging earlier than the lender would like, and can prevent you from paying down your mortgage to varying degrees.
Mortgages don’t have to be confusing and scary. They can be exciting. But before taking the plunge, have a think about your wider financial situation and your monthly outgoings, particularly your debt load. That way, you’ll know that you can afford your new home and truly enjoy living there.
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