People who don't calculate repayments are the first to get into trouble when the market turns, they lose their job, or interest rates go haywire.
Just remember the (way too recent) US Subprime Mortgage Crisis and the still-current Global Economic Downturn that it sparked!
There are some really important rules when you calculate repayments on any mortgage:
- Rule 1: Start by working out what you can actually afford to pay not by asking you mortgage adviser what you can afford to borrow based on your income and expenses! Do this by creating a strict budget (with room for savings and enjoyment, and room to carry the repayments if your property remains empty for a while).
- Rule 2: Take the amount you can afford to pay to your adviser (if you're using one), and tell them that they need to calculate the amount you can borrow based on that figure.
- Rule 3: Now ask them to calculate what you could borrow on that weekly repayment figure if interest rates were to rise by 2%.
This is how much you can actually afford to borrow.
It's not the end of the world
Remember that the rules above apply most strictly if you are buying your own home. You have a little more wriggle-room if you are buying to invest, because you will calculate repayments around the rent you expect to receive for the property.
So the rules of calculating repayments continue:
- Rule 4: Ask the mortgage broker how much you can borrow based on your income as well. This third figure (you need all three) is what you can probably afford to borrow to invest (On top of that nice fat deposit you've saved. Right?)
- Rule 5: When you calculate repayments, remember that the expected vacancy rate in most parts of the world may leave your property empty for up to 8 weeks per year. You need to be able to save enough money each year to cover the shortfall in case this actually happens to you.
As an aside, your if you're living in the eastern states of Australia at the moment, your vacancy rate will be much lower. This is because of the huge shortage of rental housing at the time of writing.
Keep an eye on vacancy rates for a guide - 4 weeks empty is usual around the 2% vacancy rate mark. Right now vacancies in Sydney and other capital cities are running below 1% and properties can receive between 60-80 applications each.
- Rule 6: Remember to factor in extra expenses such as land tax for your state, strata fees (for an apartment), lenders mortgage insurance (if your property is going to be less than 80% LVR - i.e. you have less than 20% deposit), and any time you need at the beginning to conduct renovations. This is because unless you make a long settlement (60-90 days) agreement in your property contract that includes early access to get in and do the renovations, you will have to pay the whole mortgage while you keep the property empty for refurbishment - Usually 4-12 weeks depending on scope of renovations), and be able to afford to do so!
- Rule 7: Remember that the bigger your deposit, the smaller the amount you need to borrow and the smaller the repayments. You can save money by having at least 20% deposit, because you won't have to pay Lenders Mortgage Insurance. This may not matter to you if the property is going to be positively-geared (even with a 5% deposit), but it may affect how much income you generate from the property on a weekly basis as well
- Rule 8: Calculate repayments for yourself before and after you see your mortgage adviser or broker, and do it for several different scenarios. If the figures don't add up, then it's best to move on to another deal. Check to see how much more cash flow you can get from this deal if you do it differently.
If you calculate repayments carefully, you stand a much greater chance of success. Some would say it's almost guaranteed!
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