The two-step formula to finding your 'safe' borrowing limit

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Hi Nicole. My wife and I have worked and saved hard to get ourselves into a position to finally buy a home and, with the HomeBuilder $25,000 and now a stamp-duty waiver up to $800,000 [in NSW], have started looking at developments. The trouble is we are not exactly sure of our "safe" borrowing budget – we really don't want to overextend ourselves in these difficult times – and would love your opinion. We have $150,000 saved plus another $10,000 for costs. Steve and Karen.

Guys, huge congrats on the epic savings. Stick to the budget I am about to outline for you and you will "save" even more.

A HomeBuilder grant is available for new builds that don’t exceed $750,000 in value.

A HomeBuilder grant is available for new builds that don’t exceed $750,000 in value.Credit:Paul Jeffers

You will already know that the HomeBuilder grant is available for new builds (including land) that don't exceed $750,000 in value, if together you earned less than $200,000 last tax year (it's $125,000 for singles).

The grant is $25,000, which we will assume you will need for furnishings, so I will disregard it in the loan calculations.

Now, the HomeBuilder incentive is time-critical. You must have the purchase contract signed by the end of the year and work must commence within three months of that. (You also have the right to ask for proof the house and land's value has not simply been inflated $25,000, versus a year ago.)

The second external factor you mention is specifically for first homebuyers: for one year from August 1, newly built homes priced up to $800,000 (usually $650,000) will be exempt from NSW stamp duty. It phases back in until you pay the full amount at $1 million. This saves first homebuyers up to $31,000 on a new $800,000 home.

Which brings me to my two-step formula – revised for coronavirus times – to calculate your upper price limit: what I call your "safe" borrowing ceiling.

Step 1: Multiply your deposit by five

This gives you a budget if you want to put down a 20 per cent deposit. You ideally don't want to dip below a 20 per cent deposit – or borrowings capped at 80 per cent – for three reasons:

  • Reason No.1 – You escape extortionate lenders' mortgage insurance. This can cost thousands of dollars but does nothing to protect you at all. It instead covers the lender's shortfall if you default on the loan and the property doesn't fetch enough from its sale to cover what it is owed.
  • Reason No.2 – You can access heavily discounted mortgage rates.
  • Reason No.3 – You get a nice margin of "equity safety" in case property prices dip.

Your price limit calculation: $150,000 x 5 = $750,000. This, less your $150,000 deposit, puts your potential loan amount at $600,000.

It also means you are within the thresholds for both HomeBuilder – just – and the stamp duty waiver. But there is a further sanity check on this level of borrowing.

Step 2: Your loan repayments

Figure out if your loan repayments on this amount would consume less than one-third of your salaries. More is defined as "mortgage stress" and the test simply determines if you can afford it.

Go to the excellent repayments calculator at infochoice.com.au, input your possible loan amount of $600,000, an interest rate of 3 per cent (there are even more competitive, quality rates available), select principal and interest repayments (crucial for your home) and grab the monthly repayment that you would require. I'll save you the trouble though: it's $2845.

Then, all you need do is multiply your combined before-tax monthly income by 0.333 and see whether the figure is equal to or above the repayment amount ($2845).

So your calculation is: [Your monthly before-tax salaries] x 0.333. Perhaps it's $8545 x 0.333 = $2845. In fact, that's the minimum you would need.

In normal times, I would recommend a repayment "stress test" of 7 per cent for the interest rate, too. But in these record-low-interest-rate times, just throw in 5 per cent and think about how you would cope with those extra payments.

As we enter the worst depression since the 1930s interest rates are not going up any time soon.

And hey, there could be the bonus of a $10,000 first-homebuyer grant, too, which you could pay straight off your new mortgage to save you double that amount.

You don't say where or what you intend to build, but capping your borrowings at $600,000 would cancel stamp duty, get you HomeBuilder and see you – comfortably – in a home of your own.

Nicole Pedersen-McKinnon is the author of How to Get Mortgage-Free Like Me. Follow Nicole on Facebook, Twitter or Instagram.