Hello everybody. I would like to write about something that my wife Renee (my wife) pointed out to me. In the Oct 12th 2009 edition of Woman’s Day, there was a letter on page 94.
This letter was for a section in the magazine called “Ask the experts”. It had a subheading “No matter what your dilemma, Woman’s Day’s trusty team of experts can solve it.
There was a letter from a reader who was looking to purchase a house. I will write this letter word for word so you can see what I’m talking about.
Question: I am 24 and earn $34,000. My boyfriend is 22 and earns $36,000. The bank told us we could borrow $490,000 to buy a house. Should we go to the limit? We want to get married and have kids in a few years. SHARON, Bidwill, NSW.
Answer: I must admit that it is tempting to take all the money a bank throws at you, but taking on a mortgage is a huge commitment, and will impact on future decisions.
Twenty-one percent of home owners are currently under mortgage stress, and you need to make sure you don’t become one of them. That means not accepting the highest amount a bank will lend to you. I’m not a big fan of going to a bank’s borrowing limit, and prefer to be quite conservative.
I encourage taking a loan of only 70 percent of what they say. In your case, that would mean borrowing no more than $343,000. Sure you may need to forgo buying the mansion, but each journey of 1000 kilometres starts with the first step!
I’m also a big believer in putting down a 20 percent deposit on a place. It proves you can be disciplined and save, and it also provides a buffer, should things get tough.
By not extending yourselves too much, you will have more flexibility in the future.
The last thing you want to be told in a few years time is that you can’t afford to get married or, worse, can’t have a child because the monthly interest charged on your mortgage is so crippling. What would you do if interest rates rose by four percent?
Couples considering starting a family also need to factor in a reduction of income when it comes to paying a mortgage, so it’s advisable to lodge a loan application based on one income only.
Remember that it is always better to have a great night’s sleep in an average house than an average sleep in a great home.
OK, there is the letter and the advice. There is one assumption that I am going to make about SHARON from Bidwill, NSW. This assumption is that she is not wealthy. I mean she is not taking out a loan just for the sake of taking out a loan. The assumption that I make is that she and her partner have limited savings. Maybe $10,000 to $20,000. It does not go into it in the article however; I will assume this is correct. And If I was a betting man I would suggest that this would be a good bet. I can’t be 100% sure, but in my mind this is correct.
There are two points that I want to bring up about this article.
Point Number One:
How can any bank in Australia lend out up to $490,000 to a couple earning a total of $70,000 pre tax and $61,152 after tax? In my mind this is criminal. It is plain criminal. It is irresponsible lending.
Let’s say Sharon takes out the full $490,000 over 25 years at a starting variable rate of 5.33% (This happens to be my current rate). Each week they would have a repayment of $682.40 or a yearly total of $35,484.80.
This is 58.02% of their total after tax salary. This is well beyond what I suggest at 33% maximum of your total after tax salary. This gives the couple $25,667.20 a year to live on or $493.60 a week.
This seems like a reasonable amount to live on except if Sharon gets pregnant (as she said she was looking forward to doing in the future). Now they will either drop to her boyfriend’s wage alone or have to pay extra for child care. But let’s say they have a nice relative that will look after the baby while both are at work; this doesn’t matter because either way their non mortgage expenses will go up from the cost of the child. This would eat into their $25,667.20.
If they dropped down to his wage alone, they would be $4134 down each year. This is 113.16% of his total wage going to pay the mortgage payments each year. This is before they paid one cent in food, electricity, gas, telephone, car expenses etc.
Even a 15-year-old understands that you can’t spend more than you earn day in day out before you have no money left.
However this is at the low interest rate of 5.33%. Let’s use the example from the answer person in the Woman’s Day. He said, “What would you do if interest rates rose by 4%”.
Now their home loan would have an interest rate of 9.33%. Now their weekly payment is $973.89. This is 82.81% of their total wage. This leaves them with $10,510 or $202.11 a week to live on.
Let me talk from experience. Living on $202.11 is nearly impossible for two people. Especially two people both working. There would be no room to move on anything at all. If your TV blows up, forget replacing it. If the hot water system breaks down, get used to cold showers. Forget going out to a restaurant, even once a month, if not for the whole year!
So Sharon would be walking a tightrope. No ifs, buts or maybes.
Plus I was paying 9.15% interest rates only 8 months ago. So to suggest that interest rates won’t go up again as quickly as they came down is being hopeful.
Point Number Two:
Never ask a bank what you can afford. This is like asking the barber if you need a haircut. The barber will always say yes. The bank will always lend you more than you should have.
You see the bank knows that if interest rates go up only 4%, this couple will be living on $10,000 a year. However, they don’t care. As long as they get their payment each month they are happy.
They will let their customers eat two minute noodles each night just to survive, as long as they are getting their money.
Take this advice away from this blog. Just because a big organisation (for example, Commonwealth Bank, ANZ, American Express, Visa, NAB etc.) offers you money, don’t take it as a compliment that these big companies are willing to lend you money. It does not mean you can afford it!
You need to do your figures and come up with your own conclusions.
Banks are full of salespeople (yes including tellers). I had a friend that worked for a Savings and Loans credit union as a teller. She was taught how to sell people into credit cards, personal loans, car loans and even home loans.
One of the things she was told was to look at what the customer was carrying. For example, if the customer came to the counter with a travel magazine, she was told to strike up a conversation about holidays. Then she was told to move the conversation to personal loans that could cover the cost of the holiday. In her sales training they did role plays exploring the above example.
Banks just like all businesses make money on sales. One of their biggest products is lending you money. The more money you owe them, the more they make. As long as you keep making the payments they get their profits.
So do you really think they care if you are struggling month to month just to put food on the table?
Thanks Adam Goulding (Also known as Mr Home Budget)
For more information go to
www.mrhomebudget.com.au
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