Mortgage lenders are commonly asked the same questions time and time again by their clientele, and the issue of ‘stretching’ into a large mortgage is one of the main ones, for example I was recently asked the following…

“I have just fallen in love with a property which is probably about $100,000 out of our budget but I suppose my earnings can only increase and interest rates are so low. My question is, is it insane to take on a large mortgage in this climate? We have a $200,000 income and that should increase in the coming years as the children get older. Buying this family home would give us a new mortgage of around $500,000 – we are in our mid 40s and our current house is not big enough for the teenagers our children will turn into in three years’ time. My argument is no one retires these days, I’ll still be employed when I’m in my 70s, so what harm can a large mortgage do?”

Prospective buyers who find themselves in love with a property greatly outside of their price range often wonder if they’ll be able to manage a bigger mortgage thanks to lower interest rates and speculation that their income will continue to increase over the years. They wonder whether it’s viable to burden themselves with a substantial mortgage in the current financial climate. Particularly if they are middle aged, expecting to need a larger house as their children get older, and have no hopes of early retirement on the horizon.

Here’s my view…

Firstly I’ve never really been too scared of debt, although I like to pay it off fast. I’m a little bit sensible with money (zero consumer finance debts) but my house is still my castle!

So my first really large mortgage was more than $700,000 and the mortgage is still over $700,000 (too many renovations) but the house has doubled in value in the meantime. Seven years on there is no chance we could purchase our house now, so I’m glad we took that big step when we did. We made a well thought out decision to buy a property that fitted our lifestyle and family and man did it stretch us! The thing is I’m not certain that ‘trading up’ is ever going to be all that rational.

Think about your own budget and expectations. Calculated on an income of $200,000, a prospective buyer’s borrowing potential would sit at approximately $800,000. In this case many financial experts would predict a mortgage of $500,000 to fit comfortably within that buyer’s budget.

Understandably, with larger mortgages come greater concerns from home owners about interest rates. These concerns can easily be alleviated by setting your repayments a little higher, based on a mortgage rate of 8.5 percent. The idea is that by setting your repayments higher, you will be able to initially make a bigger dent in your debt, and won’t have to worry about adjusting your repayments when your mortgage rates ultimately increase.

One of the other key concerns from home buyers is regarding to the number of years it will take to pay their mortgage off. Over a duration of 20 years and with repayments based on 8.5 percent, the monthly repayments on a $500,000 mortgage would be $4,340. For a buyer with a total income of $200,000 they can anticipate to pay a manageable 37 percent of their income after tax.

Based on an actual mortgage rate of 7.00%, the initial term of the mortgage decreases to 16 years. Once the kids leave home, if you could apply an additional $1,000 each month onto the mortgage, the term then plummets to 12 years.

Obviously while you’re focusing on life and work and repaying your mortgage, your property value and your income will both be rising by no less than the rate of inflation. If you then choose to just add half of your annual wage increases to your mortgage repayments you could trim nine years off a 25 year mortgage.

The great news is that if you are considering buying property in one of the main centers – particularly in Auckland – your property’s value will increase at a much faster rate than inflation thanks to population growth and subsequent property demand. Just think about housing values and how they have continued to increase in places like Sydney and Melbourne.

Still have your concerns about stretching yourself into a larger mortgage? It’s always good to exercise caution before making such a huge commitment, and luckily for you most of the other possible risks associated with a big mortgage can be reduced or removed all together with good insurance. This is especially important for prospective buyers approaching their 40s, but all home owners should ensure they have appropriate and extensive life, medical and income protection insurances.

Author Bio: John Bolton is one of New Zealand’s leading experts on property finance, particularly mortgages and interest rate risk management. His business, Squirrel Mortgages, helps New Zealanders buy over $10m of property every month.

Category: Finances
Keywords: mortgage,home loan,debt,personal finance