Autumn 21

Low interest rates, skyrocketing house prices, loan-to-value (LVR) restrictions and debt-to-income (DTI) ratios are all hot topics.

Ironically, the LVR restrictions have had hardly any short-term impact because people’s house values have gone up more than enough to offset them.

With so much hype in the housing market, it’s hard to sift through the junk to find the quality.

It’s then even harder to work out what it all means for you. Here’s an easy guide to mortgages in this market.

It’s FOMO

Not surprisingly, hype in the housing market and low interest rates have driven a crazy amount of activity, pushing up property values.

We’re all human and we’re suffering from a severe case of Fear of Missing Out (FOMO). The housing market’s the winner.

The Netflix show Boom Bust Boom explains this perfectly.

But buying a property is still a good thing. It’s something you should aspire to and be proud of when you do it. Whether it’s your first or your tenth property, it shouldn’t be stressful.

At every stage of life, buying a property and taking out a mortgage can be exciting, but it’s important to understand the daunting parts. Knowledge is power.

Affordability

As I write, debt-to-income ratios have been talked about but not yet brought in.

These would dramatically change how banks assess the affordability of your home loan and what you can borrow. Honestly, I hope they don’t come in.

For now, banks assess your affordability using a ‘test’ rate to see if you could still afford your loan if the rate goes up.

For most banks, the test rate sits between 5.5 per cent and 6 per cent – even though the real rates are around 3.5 per cent below that.

Banks then assess how affordable your loan will be over 30 years, paid as principal and interest. There are a couple of variables:

If you’re over 45, banks may shorten the term they test you on, expecting you to have a shorter working life than 30 years. Shortening the term will cut how much you can afford.

If you’re an investor and you want an interest-only loan, the bank will assess the affordability of your loan based on a 30-year term, minus the number of years interest-only. If you want five years interest-only, you’ll be assessed over a 25-year principal and interest term – again cutting your borrowing power.

Understanding what you can afford is really important in any market – and especially in this one.

Get a pre-approval and try out a few banks because they’re not all the same.

Structure

How you structure that debt depends on a number of things.

You’ll often hear the advice that investors should put a house on interest-only for as long as possible, and that owner-occupiers should get debt-free as fast as they can.

I’d say that’s not always the best solution.

Instead, focus on your own circumstances and how to make the mortgage work best for your future.

Borrowing to invest

Leveraging equity from your existing house is a hot topic right now because property values are rising steeply.

If you’re a homeowner wanting to grow your portfolio and there’s equity in your home that you can borrow against, it’s important to understand how to leverage it.

In simple terms, you’re able to borrow 80 per cent against your owner-occupied home and 70 per cent against your investments.

Let’s say you have a home worth $1 million and an investment worth $600,000. You can get a maximum loan of $1,220,000 but you do need to afford the mortgage.

Let’s assume you have $400,000 lending against your home and you borrowed the full $600,000 to buy the investment. That means you have $220,000 that you can use as equity. That’s what you can use for deposits on future purchases.

For your next investment purchase, you need to have a 30 per cent deposit for existing houses or a 20 per cent deposit for a new build.

This means that $220,000 gives you the ability to spend $730,000 on existing properties or $1,100,000 on new builds.

Understanding how to leverage your equity and use it correctly is a fundamental investment rule.

To get the most effective tax benefits, get advice from people who know what they’re doing.