How much should you borrow for a home loan?

author-avatar By on September 24,2018
How much should you borrow for a home loan?

It’s every home buyer’s first thought – how much should I borrow for a home loan?

The amount a lender may be willing to let you borrow isn’t always the amount you should borrow. It’s important to take into consideration all your personal finances before making a purchase decision as borrowing more than you may be able to afford to repay in the future can lead to a really bad financial outcome.

How much should you borrow for a home loan?

When taking out a home loan, everyone’s existing and future financial situations are going to be somewhat unique – so let’s first take a look at what the lending industry thinks before investigating the additional factors that are likely to be applicable to you as an individual.

The lending industry indirectly recommends that people not borrow more than 80% of the property value through the general application of policies which enforce that borrowers pay for Lenders Mortgage Insurance (LMI) in order to be approved for a loan worth more than that.

Effectively, they are saying that buyers should have at least a 20% property deposit saved. A 20% deposit on a $450,000 house is $90,000!

Essentially, lenders are protecting themselves from a situation where:

  • a borrower ‘defaults’ on the mortgage (unable to pay or ‘service’ the loan), forcing the bank to repossess the property AND
  • the value of the property has fallen to be worth less than what’s owed on the mortgage

In this situation, the lender might not be able to fully recover what’s owed to it by selling the repossessed property – resulting in a loss for the lender.

Low rate home loans

Provider
Ad rate
p.a.
Comp rate*
p.a.
Monthly
repayments
 
2.84% 2.80% $1,652 More details
2.95% 2.99% $1,676 More details

Base criteria of: a $400,000 loan amount, variable, principal and interest (P&I) home loans with an LVR (loan-to-value) ratio of at least 75%. The product and rate must be clearly published on the Product Provider’s web site. Introductory rate products were not considered for selection. Monthly repayments were calculated based on the selected products’ advertised rates, applied to a $400,000 loan with a 30-year loan term. Rates correct as at 17 February 2020. View disclaimer.

Can’t afford a 20% deposit?

You may still be able to be approved for a home loan with a deposit of under 20% of the property’s value. For many lenders, the minimum required deposit is often 5%.

But there are two things you should consider when applying for a home loan with a deposit under 20%:  

  1. Lender’s mortgage insurance: Typically, borrowers that don’t have a deposit of at least 20% are required to pay for LMI, which can add tens of thousands to the cost of the mortgage, depending on the lender and what loan-to-value ratio (LVR) percentage you have.  
  2. Guarantors: If you can get one of your family members to act as a guarantor, you may be approved for the mortgage without having to pay LMI. To be successful, the family member must be able to demonstrate either their own capacity to repay your loan and be willing to be liable for your home loan if you default on a payment or to put their own property equity forward as collateral.

Getting a better idea of your financial capability: Five things to consider

No matter which path you take with your deposit and securing a loan approval, it’s essential to calculate your personal finances to give you a better idea of just how much you should (not ‘could’) borrow. Here are five things to consider before taking out a mortgage.

1. Household income

When assessing your finances, ask yourself what kind of lifestyle you want. Are you single? Married? Have a baby on the way? Do you like designer shoes or do you eat out regularly? Ask yourself if you’re willing to make sacrifices and if so, where are you going to reduce your spending? Your household income is one of the first things a lender will look at when determining if you’re eligible for a home loan. If you can show a record or budget of your spending habits per week, this can help prove you’ll be able to meet the repayments required.

2. Credit rating

A credit rating, or credit score, is the next thing a lender will look at to determine how much a risk you are as a borrower. Many people don’t ever check their credit rating and are surprised when their application gets refused. It’s a good habit to check your credit rating once a year to make sure you’re either on the right track or working towards improvement.

3. Property price and value

The next thing a lender will assess is the type of property you’re interested in and what purpose you’re buying the property for. Is it an investment property or are you looking to live in the home as an owner-occupier?

Another important thing to consider is the value or potential future value of the property you’re purchasing. Are you buying a house, apartment or land?

These questions will all have an impact on your borrowing power.

4. Home insurance

Home insurance is designed to protect your property from damage caused by events out of your control. As your home is your biggest investment, it’s important you ensure you’re able to afford home insurance before applying for a home loan.

5. Other costs

Similar to home insurance, there are a number of costs (both upfront and ongoing) associated with buying and owning a property. A few of these include stamp duty, LMI (if applicable), home loan establishment fees, legal and inspection costs, council rates, water utility rates and general property maintenance.

Buying a home is a big decision and should not be taken lightly. Assessing your borrowing capacity is just one of the ways to determine how much you can borrow for a home loan, but working out how much you should borrow will always be a personal decision based on a raft of other individual factors including how much risk you can tolerate and how much you are willing to sacrifice to ensure that you can make the most of your valuable property purchase.


Disclaimers

The entire market was not considered in selecting the above products. Rather, a cut-down portion of the market has been considered which includes retail products from at least the big four banks, the top 10 customer-owned institutions and Australia’s larger non-banks:

  • The big four banks are: ANZ, CBA, NAB and Westpac
  • The top 10 customer-owned Institutions are the ten largest mutual banks, credit unions and building societies in Australia, ranked by assets under management in November 2019. They are (in descending order): Credit Union Australia, Newcastle Permanent, Heritage Bank, Peoples’ Choice Credit Union, Teachers Mutual Bank, Greater Bank, IMB Bank, Beyond Bank, Bank Australia and P&N Bank.
  • The larger non-bank lenders are those who (in 2019) has more than $9 billion in Australian funded loans and advances. These groups are: Resimac, Pepper, Liberty and Firstmac.

Some providers' products may not be available in all states. To be considered, the product and rate must be clearly published on the product provider's web site.

In the interests of full disclosure, Savings.com.au and loans.com.au are part of the Firstmac Group. To read about how Savings.com.au manages potential conflicts of interest, along with how we get paid, please click through onto the web site links.

*The Comparison rate is based on a $150,000 loan over 25 years. Warning: this comparison rate is true only for this example and may not include all fees and charges. Different terms, fees or other loan amounts might result in a different comparison rate.

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author-avatar
Dominic Beattie is the Editor of Savings.com.au. He has been publishing articles on finance, business and economics since 2015, having previously worked as a Senior Journalist at financial research firm Canstar before helping to launch Savings.com.au in November 2018. Dominic aspires to help everyday Australians discover simple and effective ways to comfortably manage their finances and save money, without sacrificing their joie de vivre.

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