Maxxed to the Max…
What’s my maximum borrowing I can get on a loan?
Who cares!!!
I was asked by a reader a few weeks ago to do a story on my take of maximum borrowing… so here we are.
The only real time that anybody should be borrowing their maximum borrowing from a lender is when they know their income is going to increase significantly in the immediate future or they receive “cash” as part of their income and can only declare a lower amount. And if anyone from the ATO is reading this – I don’t know any people who earn cash…
We are living in unprecedented economic times with the USA talking about another recession now and Europe being in very poor health. So why would anyone stick their necks out and borrow their maximum amount. I am all for “Having a Go” in tough economic times, as this is where you can make some great money on property, but it is all an educated risk…
We currently have ultra low interest rates and when lenders work out a clients maximum borrowings, they take this into consideration and make sure you can service the debt at around 2% higher than current interest rates… but what happens when they rates go back up to 8%. If you borrow your maximum at 5.8% then you are surely going to drown at 8%, so where does borrowing your maximum make any sense?
You only live once, so why live it with financial stress???
My investing philosophy is buying property from vendors who are experiencing financial stress and releasing them from this burden. Sure I buy cheap… but they also get to move on with their lives… so I see first hand what this stress can do to people and families… and its not worth it!
Sure you could lock your loan in on a great fix rate, but what happens if when the fixed rate matures, the variable rate is 8% or higher???
When I invest, I do my calculations with an interest rate of 9%. If I can afford the property at this level, then I proceed. This way I am covered even if rates go up to above 8%.
But what if rates go above 9%???
I would find this rather unlikely for the below reason. When I purchased my 1st home, a 1 bedroom unit in Cronulla, the interest rates 11.75%. They were on the downward slide of the late 80’s/ early 90’s recession where interest rates hit around 18%. When we purchased this unit our net income to loan repayment ratio was under 20%… meaning that if we received $1000 net per week between us both, then our loan repayment under $200 per week.
This is why those who lived through the 18% rates were able to still survive…
That ratio went as high as 60% before the GFC, so when an interest rate increase of 0.25% occurred, mortgage owners really felt the pinch. Add a few more of these interest rate hikes and borrowers are going bankrupt.
Add a pregnancy is job loss into that mix and you can see how borrowers got themselves unstuck…
So when interest rates go over 8%, we see huge amounts of mortgagee in possession properties. Over 9% and we will have a housing catastrophe…
In my own portfolio, I still factor in this as a possibility, so I keep my Loan to Value Ratio LVR to under 60%. Meaning if I had $1 million in property, I only owe $600,000. That way I have plenty of room should the property market shift downwards quickly and interest rates go up, I can still see for a reduced price and not go bankrupt.
This ratio has relaxed again now post GFC but the number is still around 45% – 50% of net income. This is still too high in my opinion.
When I work out what my tenants can afford to pay in rent in my investment properties and client’s properties, I use 33% net income. This ultra conservative approach means we have very few rental arrears on our properties and allows for rental increases every 6 months of $10 per week.
Now I have that off my chest, let’s look at a more practical side of finance. When I talk to clients who require finance to fund their home or investment property purchase, my first question is:
How much could you afford to lose each week, I mean if you had amount of money missing from your wallet each week, what would that number be?
From here I can work backwards and work out what loan amount that would be. I find that this figure is far lower than the maximum borrowing amount and far more affordable and practical.
The other factor to consider when working out maximum borrowing power is your deposit size. If you don’t have the require deposit then you cant get the loan… let me explain. If an executive who earns $150,000 per annum only has a deposit of $30,000 then their maximum borrowing for a loan is around $300,000. Now they can afford to repay a much bigger loan but to purchase that property they require a minimum 5% of the purchase price plus stamp duty and set up costs as deposit, which they do not have. If they can get a bigger deposit then their maximum borrowing amount will increase.
That aside, there are significant differences between the banks and lenders. It’s these differences that separate them from their competition? They all sell money by way of mortgages and other financial products, and they all say they are different and better from their competition… but what does this really mean?
Every lender in the mortgage space has their flavor of lending and lean their product policies towards this flavor. Some lenders prefer investment loans; others prefer borrowers with a lower risk sub 80% LVR and reward borrowers who can achieve this by way of a lower interest rate.
This is where we come into the equation. As mortgage brokers, we need to know all the ins and outs of lenders to take that pain away from you, the consumer.
Employment type can also alter the banks maximum borrowing, or any borrowing at all. A few examples of harder employment types could be:
- Maternity Leave
- Contractors
- Ex Pats
- Overseas borrowers
- Part time or casual workers
- Self employed
- Low base – high commission earners
- Employees on probation
In general lenders do not like some of the above employment types but funny enough if the LVR is below 80% then they may consider on a case by case scenario. This would obviously affect the amount of money you could borrow.
Other considerations like car loans; personal loans and high credit card limits have a negative effect on the amount you can borrow. Now although you may only owe a small amount on your card, if you have a high limit, then you have the ability to spend that limit at any stage and therefore increasing your debt and making the loan unaffordable.
So my advice is, that you borrow to your practical maximum, not the maximum the banks will give you… or one day I may be knocking on your door, ready to buy your property for 30% below market value!