Things have changed since your parents purchased their first home.
Even though banks and loans have been around for a very long time the mortgage market is continually changing so you need to know how to go about buying and borrowing in today’s market.
Amateur advice and Government accreditation
The Government now accredits people to provide advice about loans and they must follow strict guidelines in advising you to ensure you don’t get into a loan which is unsuitable for you. Financial advisors such as accountants and financial planners cannot provide you with borrowing advice unless they also hold an Australian Credit License.
Not all loans are the same
Most banks have similar type of loans but the details of who they will lend to, how much they will lend and how much they will charge varies considerably. Also banks and other lenders also have loans for those that don’t fit neatly into the bank’s standard lending rules.
Try to fit into the banks box if you can
It’s best if you can arrange your finance affairs to fit the bank lending rules so you should do some planning with your lending advisor well before you actually start looking for a loan. You might be surprised by what you might need to consider. Here is an example list:
- Time in current job and current industry
- Type of employment – casual, part-time, full-time, contractor, self-employed
- Overtime or sessional income
- Car Allowances
- Other allowances – eg. shift, uniform
- Superannuation payments
- Source of deposit – bank account, shares, gift
- Credit history
- Expected life changes – eg. having children
Outside the box costs
If you don’t fit into the “normal” box then you could still get a loan but you may end up paying higher loan costs than you’ll see in a bank’s advertisement.
How much can you borrow?
While there are many aspects lenders consider when you apply for a loan, the most important factors in determining the amount you can borrow will be the amount of deposit you have and the your ability to make loan repayments.
What is a deposit?
The answer is not as simple as you think. A real estate agent will see a deposit as the amount you need to pay the property seller when you sign a purchase contract – usually 5 or 10% of the purchase price.
BUT most people also refer to a deposit as the amount that you have to contribute to a property purchase on top of what the bank will lend you. This is usually substantially more than that 5 or 10%. Let’s call this the “bank deposit”.
How much is your “bank deposit”?
Working out the bank deposit is not quite as straight forward as you’d think and is one of the biggest traps for First Home Owners. On top of purchase price of you have to pay for Government stamp duty, legal fees and potential mortgage insurance (see below). You have to add these to the purchase price subtract the loan amount to work out what you need to pay as you “bank deposit”.
Proof of Bank Deposit
Before the bank approves your loan they will want to see written proof that you have the money for the “bank deposit” and that you’ve held it or saved it over a minimum number of months. You might be able to use a gift for your bank deposit but not all lenders will accept this and you’ll need to documented proof of the gift.
First Home Owner Grants and Government Assistance
First Home Owners may be eligible for Government assistance in the form of a grant or stamp duty concessional rates which can effectively reduce your “bank deposit”. These change over time and vary between states.
If you think you will need to borrow more than 80% of the property purchase price then mortgage insurance will be an important cost you need to consider. Mortgage insurance is an insurance taken out by the lender on your mortgage. It is a once-off payment at the beginning of the mortgage and all lenders require the borrower (you) to pay the cost. The cost increases the higher the loan percentage and loan amount get. Typically mortgage insurance is a few thousand dollars.
Building your first home
Many first home owners purchase land and have a house built on it. In Victoria this has the advantage of reducing stamp duty but there are some complexities which really need an experienced professional to explain to you and help you plan for.
Most importantly you will usually start paying your mortgage payment as soon as you buy the land – i.e. before you have a house built on it and your government assistance may not be available to until after building commences.
Most banks will want details of your last two or three year’s employment. If you have been working less than 12 months in your current job or have inconsistent employment over the last three years you will definitely need to consider the details of the bank’s employment history rules. Documented evidence of employment will be required.
If you are self-employed, most lenders will expect two years history. Commonly you will be asked for two year’s tax returns and financials but there are other loans where alternative verification of income will be accepted. These are commonly referred to as Lo Doc (or Low Doc) loans.
Family Help/ Guarantees
Frequently parents have helped their adult children with purchasing their first home in the form of monetary gifts, using the partial home as security to borrowing or repayment guarantees. Government regulations designed to enhance consumer protection have made this type of assistance more complex. Both choice of loan product and structuring of the arrangements with the parents are critical to get right.
Risks – rates and life changes
Borrowing money comes with risks and the danger for First Home Owners is over stretching with the loan. Mortgages run over decades and your circumstances are certain to change over that time. Banks factor in the potential of interest rate rises when they work out how much you can borrow. But the impact of life events such as job loss or pregnancy/children need to be factored into your plans. You need to talk to a professional about planning for these risks.
When you apply for a loan the lender will obtain a credit history report on you. If you’ve had prior problems with loan, telco, power or other commercial accounts you may have items on your credit report which could damage your loan application. If you think this could be a problem it’s best to obtain your own copy of your credit report before you apply.