Stretching Yourself Into a Big Mortgage
As a mortgage broker I regularly get the same questions again and again. This one about stretching into a big mortgage is a typical example…
“I have just fallen in love with a house which is probably about $100,000 out of our price range but I figure my income can only go up and interest rates are so low. My question is, is it outrageous to take on a big mortgage in this climate? We have a $200,000 income and that will hopefully rise in the coming years as the kids get older. The buy of this family home would give us a new mortgage of around $500,000 – we are in our mid 40s and our current home is too small for the teenagers our kids will turn into in three years time. My argument is nobody retires these days, I’ll nevertheless be working when I’m in my 70s, so what harm can a big mortgage do?”
Here’s my view on ‘stretching’ into an oversized mortgage.
Firstly I’ve never really been too afraid of debt, although I like to pay it off quickly. I’m a little bit sensible with money (zero consumer finance debts) but my home is nevertheless my castle!
So my first seriously big mortgage was over $700,000 and the mortgage is nevertheless over $700,000 (too many renovations) but the house has doubled in value in the meantime. Seven years on there is no way we could buy our place now, so I’m glad we took the drop when we did. We made a conscious choice to buy a character that fitted our lifestyle and family and boy did it stretch us! The thing is I’m not sure that “trading up” is ever going to be all that rational.
Based on an income of $200,000 this persons borrowing strength is around $800,000 so I’d say a mortgage of $500,000 is well within their budget.
With bigger mortgages, people naturally get more nervous about interest rates. The easy way to solve this is set repayments based on a mortgage rate of 8.50%. By setting repayments higher, you will initially pay the mortgage off faster. When mortgage rates ultimately increase your repayments do not need to change.
The other shared concern is the time it takes to pay-off a mortgage. Based on a 20 year term and setting repayments based on 8.5%, monthly repayments would be $4,340 or only 37% of your take home pay (assuming $200k gross as in this example).
Based on an actual mortgage rate of 7.00%, the initial term of the mortgage drops to 16 years. And taking this example further, once the kids leave home, applying an additional $1,000 per month onto the mortgage would drop the term further to 12 years.
And whilst all of this is happening, character values and income are at worst increasing at the rate of inflation so servicing gets easier over time. If all you did was put 50% of your salary increases against the mortgage you would shorten the life of a 25 year mortgage by 9 years.
Of course if you are buying in a main metro area (Auckland especially), then long-term your character will do better than inflation if only because of population growth. This is especially true of similarities closer to the centre. Look at cities like Melbourne and Sydney (simply in terms of population demographics) and you can see the future.
Most of your other risks and concerns can be reduced or deleted with insurance. In particular make sure you have appropriate Life and Income Protection policies. In your forties you have less time to dig yourself out of trouble if something goes wrong.