Taking out a mortgage is generally a major life event, especially if it’s your first mortgage. When done correctly, a mortgage can bring huge financial gains, and be a great investment.
However, before you sign on the dotted line, there are a few rules of thumb that you should consider to ensure that you’re borrowing well within your means.
To prevent yourself from unnecessary financial stress, run through the below financial tips before signing off on a mortgage.They are designed to help you calculate just how much money you can borrow and comfortably make repayments on.
Rule 1: The 20% down deposit rule
When taking out a mortgage, almost all lenders will require some form of down deposit. This is often a 20% monetary deposit. However, there are some lenders who will offer mortgages to borrowers with a lower down payment, sometimes as low as 5%. While this lower deposit may make a mortgage more accessible to many people, it’s not necessarily a good idea to take out a loan without at least a 20% down payment.
Mortgages with a higher deposit are generally linked to lower interest rate. This is because the lender sees a lower risk of lending the money due to the borrowers having a higher stake in the property.
A larger deposit will also lower or eliminate lenders mortgage insurance (LMI) costs. LMI is an initiative that protects lenders should their borrowers default on payments. The cost of LMI can be significantly high, and varies depending on the amount borrowed and the deposit that’s put down.
Rule 2: Don’t take out a mortgage that’s worth more than your five times your gross annual salary
It can be tricky to calculate just how much money you should take out for a mortgage. Of course, it’s important to stay within your financial means, but how do you come up with an exact figure?
A helpful general rule is for a borrower to calculate their gross annual salary (or combined salary for a couple) and times it by five. This figure helps to give a ballpark amount of what the borrower can comfortably afford when it comes to borrowing a large sum.
However, if the borrower already has a large amount of savings that is intended to go towards the house, then this can be added onto the final figure that’s calculated.
Rule 3: The 28% monthly rule
The 28% rule is another helpful calculation when deciding how much money you should take out on a mortgage.
The rule is recommended by many financial investors and stipulates that borrowers should ensure that their mortgage repayments shouldn’t exceed 28% of their gross monthly income. When the repayment ratio is higher than 28%, potential borrowers may not have the financially means to meet their repayments, and cover their other expenses.
Many financial institutions may deny a potential customer a loan if they calculate the repayments to be higher than 28% of their gross monthly income.
Rule 4: Apply the 28% rule to 28/36% rule
The 28% rule is commonly used in conjunction with the 36% rule. The 36% rule stipulates that no more than 36% of your household income should be spent on debt repayments. This includes mortgage payments, credit card repayments, car loans etc.
So, when the two rules are applied together, they recommend not spending more than 28% of the total income on mortgage repayments, and not exceeding 36% of total debt repayments.
Rule 5: Have an emergency fund to cover 3-6 months of house expenses
Whether it’s a surprise redundancy, or an emergency medical bill, the reality is that unexpected expenses pop up, and these costs can make meeting your monthly repayments difficult and/or stressful.
Before taking out a mortgage, it’s a very good idea to have an emergency fund, should you find yourself in a situation where you can’t meet your repayments. A general recommendation is to have savings that are equivalent to 3-6 months of total house expenses. This includes mortgage repayments, utility bills, taxes, and insurance.