If you’re a first home buyer and trying to crunch the numbers as to what you can potentially afford to borrow, debt to income ratio is a concept that may help.
According to recent data released by RealEstate.com, it’s currently cheaper to buy a house than rent one based on 56.8% of dwellings located in Australia. Despite surging property prices, we can thank record low interest rates for this current costings estimate, with the swing even higher for units and apartments.
The analysis shows 51.2% of houses in Australia will be cheaper to buy than rent over the next decade, which is considered to be the average time period that homeowners hold on to their properties. The results were even higher for units, with 72.7% cheaper to purchase over the same time period.
Thus, despite what the news is telling you, buying your first home in today’s market is still within reach provided you approach the task with some flexibility, and realistic expectations. Just because house prices are increasing, it doesn’t mean that you should start looking at bigger loans if you can’t necessarily afford to do so – but how exactly do you calculate what you can afford? Enter, the debt to income ratio.
Understanding Debt To Income Ratio
Debt to income ratio is a term we use to describe a personal finance measure that compares the amount of debt you have to your overall income. Many lending providers who issue mortgages and home loans, use your debt to income ratio as a means to measure your eligibility for credit based on your perceived ability to manage repayments.
The type of debt and credit that financial institutions generally consider when calculating your debt to income ratio often include:
- The amount currently owing on credit card debts
- Instalment plans or ‘Buy Now, Pay Later’ services such as Afterpay or Zip Pay
- Personal loans
- Car loans or asset finance
- HECS/HELP loans
- Pre-existing home loans
- Investment loans, lines of credit and/or margin loans
As a general rule, if the information doesn’t show on your credit report, it’s not factored into your debt to income ratio by lending providers.
In order to calculate your current debt to income ratio, all you need to do is add up your total credit or debt balances, and divide it by your total gross annual income, such as your salary or wages before tax and other deductions are taken out.
Hypothetically, let’s say you are in a de facto couple, and you have a home loan of $400,000. You also have a personal loan for your car which owes $14,000 and you have a credit card debt of $4,000 that was used to buy a new television. To pay for all of these things, you and your spouse take home a salary of $80,000 each per annum, which takes your total liabilities to $418,000, while your total gross income per annum is $160,000.
By dividing $418,000 by $160,000, the debt to income ratio for this couple is 2.61, which is generally a pretty favourable number on the lending scale. While each bank has a different set of rules when it comes to lending criterias and debt to income ratios, most of the big four banks restrict loans for those with a debt to income ratio that sits higher than 7 to 9.
In order to get approved for a home loan, you need to present yourself as a favourable lending candidate. Long before you even think about applying for a mortgage, dig into your own financial history by obtaining a copy of your credit report to ensure that there’s no nasty surprises that could potentially see you knocked back. Many lenders are consciously looking at whether you can afford to take on any more financial responsibilities, and if you’re likely to default on the loan or not.
As such, it’s always a good idea to consciously try and minimise as much existing debt as you can before you apply for a mortgage. If you’re struggling with presenting a loan application or aren’t sure where to start with your finances, it’s always a good idea to consult with a mortgage broker before you start applying for credit that could potentially damage your credit score.
Taking The Stress Out Of Your First Property Purchase
The big attraction of buying your own home is just that – it’s yours, once you’ve paid back the banks of course. Apart from having somewhere to live, the quest for home ownership is also about having a long term investment strategy. If we’re looking at it from the viewpoint of decades instead of months, generally house prices do rise, and so does the value of your investment.
Buying your first property is also one of the first steps of building wealth, as the equity in the home will usually allow you the opportunity to access further loans if that’s what’s on your radar, such as shares, a managed fund, or even a second investment property. However, entering the market as a first home buyer isn’t always easy, which is why we’ve compiled our very own in depth First Home Buyers Guide. This resource is completely free to download, and can be a game changer when it comes to ensuring that you’re up to speed on how to get into your first home faster.
With a background in banking, finance, business development and project management, there’s no better advocate to have on your team than Nikki Berzin. As a fully qualified mortgage broker and director of Cherry Lending & Finance, Nikki is passionate about all things finance, and empowering her clients with the tools to hit their property goals is what she does best, and another example of this is the free to use Savings Goal Calculator found on the Cherry Lending & Finance website.
If you’re looking to get into your first home, purchase an investment property or even want to look at your options for refinancing, the first step is starting the conversation. Get in touch with Nikki today, or call her directly on 0427 374 155 to bring your mortgage dreams to life.
Disclaimer: Your full financial needs and requirements need to be assessed prior to any offer or acceptance of a loan product. Subject to lenders terms and conditions, fees and charges and eligibility apply.
Credit Representative 499652 is authorised under Australian Credit License 389328.
