Stress test your mortgage in advance
17 Jun 2013
As a financial adviser, all too often I meet clients who have overextended themselves when purchasing a property, usually their own home. People often get confused that the generosity of banks to lend them vast amounts of money constitutes a capacity to repay those amounts, plus interest.
It is critical to understand that a bank, by virtue of holding a mortgage over your property, will often take out mortgage insurance to protect themselves if you default, with the consequence, that a lender might lend a higher amount than what can be comfortably repaid.
Some banks and lending institutions will default to the 'Henderson Poverty Index' (HPI) as a reference point for living expenses which might not reflect your true living expenses. Using HPI frees up cash flow in the lender's calculator to commit more towards mortgage repayments, which could end up in unrealistic loan amounts that tempt people to purchase properties of higher value. It is vital that your true living expenses are taken into consideration.
Everyone wants a bigger, better property and when a lending institution gives you the green light to spend more than you may have expected, it can lead to your emotions taking over and over committing yourself.
At Shadforth we have developed a sophisticated financial modelling tool that we use with clients to help them make informed decisions about a range of financial and lifestyle choices. It can identify when certain strategies are likely to work better than others, including risk-taking, negative gearing, superannuation use and early or late retirement. In addition, it is extremely powerful when helping people decide about how much they should borrow to buy a property.
The modelling tool will allow future projections of income and spending patterns, taking into
- account absence from work when raising children
- childcare costs
- house maintenance costs
- car changeovers
- holidays, and
- anything else relevant to you.
Having used this tool many times with clients who are looking to take out a loan to buy property, it has been invaluable in setting realistic borrowing limits. In one case the bank was willing to lend a couple $1.2 million however our modelling suggested that $700,000 was more achievable. Had they borrowed the $1.2 million that the bank was 'generously' willing to lend, they would have found themselves in cashflow trouble in no time!
And the best part is, if you utilise Shadforth's mortgage broking services we can include the financial modelling analysis as part of that process free of charge. Where young couples are purchasing a property for the first time and taking on a large amount of debt it is also important to consider insurance cover to protect the family. That is also part of the Shadforth service offer.
So be aware that what a bank or lending institution will be willing to lend, may not be what you should borrow. It is very tempting to take the higher offer and buy a better property, however you will often find yourself under too much pressure which in the long run could cost you tens of thousands of dollars.
Instead, you can get the best of all worlds by seeing a Shadforth Private Client Adviser and working with our mortgage broker. We can help you understand the sustainable loan value and also see what your financial future may look like through financial modelling, as well as protecting you and your family through insurance. And when it comes to cost, where you implement through Shadforth, it won't cost you an extra cent!
To learn more about Phillip, view his online profile.
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