How much should you borrow for a house? It’s an important question because a house is the most expensive thing you’ll buy whilst taking on lots of debt.
Banks like Commonwealth Bank of Australia (ASX: CBA), Westpac Banking Corp (ASX: WBC), Australia and New Zealand Banking Group (ASX: ANZ) and National Australia Bank Ltd (ASX: NAB) want to lend as much as possible.
Real estate agents like Mcgrath Ltd (ASX: MEA) want buyers to pay as much as possible for a property.
House prices are surging at the moment with investors and first home buyers suffering from FOMO. National house prices rose 1.7%, Sydney house prices rose 2.7% and Melbourne house prices increased by 2.2% in just November 2019 alone.
But home buyers should be careful about what they get themselves into. A mortgage is for 30 years, not just one or two years. It needs to be affordable for the entire period.
Each household needs to ultimately decide what level of debt they’re willing to sign up for. But there are some general guidelines which you can follow. It’s generally a good idea to limit the mortgage payment and other property expenses to a max of around 30% of the monthly budget, 25% (or less) of the budget would be a more comfortable number.
With interest rates being so low you need to give yourself a bit of a buffer in-case rates rise. If your loan repayments are based on a 3% or 3.5% interest rate your budget should be able to cover the repayments if interest rates rose and sent the cost to 5% or 5.5%.
But, taking on debt is more than just the monthly repayment. Aussies are perhaps the most indebted country in the world with huge mortgages. Debt isn’t just a made-up number, we need to eventually pay all of that debt back.
How much debt do you want to take on? Banks have their own limits of how much debt they’re willing to lend compared to the borrower’s income. So even if you want to borrow 20 times your income you’ll be faced with the bank’s own ratio limit.
Taking on a $500,000 mortgage is much riskier for someone with $50,000 of annual income compared to someone with $100,000 of annual income. I think a debt to income limit of six to one is probably a decent idea with interest rates being so low, but it could be lower in regional areas and may need to be higher in Sydney.
Do you have to buy a house?
There’s nothing to say that people must buy a property to live in. Some people are priced out of the property market, but long-term renting isn’t all bad. Annual property expenses are lower, at least for the medium-term before inflation catches up. If the renter invests a lot into shares then their net worth may be able to keep up. Rent money may be dead money, but interest, building insurance, water rates, council rates and (if applicable) body corp fees are also ‘dead money’.
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