Whether you’re a first home buyer, purchasing your next house or a new property for your investment portfolio, entering or re-entering the property market is exciting. You may have worked hard to save a significant deposit or built enough equity in your home to purchase another property and want to jump right in. However, before you take the next step, it’s important to consider your current financial position. While it’s common to do a mortgage stress test after you purchase property, completing a budget stress test prior to purchasing can save you a lot of hassle (and money) down the road.
If you’re looking to start or continue your property-buying journey, read on for more about testing your budget to find out if making this purchase is feasible for your current financial situation.
Defining financial stress
Financial stress (or financial hardship) is when a person struggles to meet basic financial commitments due to a shortage of money. This can lead to various problems – immediately and down the track. It also leads to someone’s anxiety levels as they worry about making ends meet and often live pay cheque to pay cheque.
What is a budget and mortgage stress test?
Homeowners may have heard about undertaking a mortgage stress test against their current home loans. However, stress testing your budget is important and should be done before buying property. If you’re unsure how to stress test your budget, here are some suggestions to consider.
While stress testing your mortgage is relatively easier, it’s a little harder to create a formula on how to measure financial stress in your personal budget. However, regularly looking at your finances in a hypothetical stressed economic and personal environment to see how well you can manage is a valuable exercise.
Loss of income
One of the best ways to stress test your budget and financial situation is to imagine a hypothetical situation where your regular income stops. If this were to happen, how would you fund the essential payments needed to live (e.g., rent/mortgage, food, electricity, etc.)? Analyse your bank balances, investments, debts or withdrawable investments. Ideally, you should have at least six months minimum of funds stored away for an emergency fund.
Like a loss of a job, other unexpected scenarios might pop up that need your immediate attention. This might be needing to buy a new car because yours broke down, finding out a family member is sick or taking your furry friend to the vet. Sometimes, we go into routine check-ups or services and have our world thrown into chaos. Plan for the worst and ensure your finances can help you through if these things arise.
Why stress testing your budget is crucial before buying a house
Before you buy a house, stress test your budget. Put it through a range of scenarios with your mortgage broker – both with your finances as they stand as well as estimating costs if you were a homeowner. Stress testing your budget against future scenarios means you can gauge how your budget would go against a home loan. (Keep in mind, this would be a rough guide only). It will help show you whether you’re in a position to service the (hypothetical) loan.
Being realistic when house hunting and what to consider before buying
Before purchasing a property, you need to be realistic about house hunting and what’s reasonable for you and whoever else you may choose to buy with. Here are some things to think about.
Set a firm budget
Yes, we know budgets put a bit of a dampener on the home-buying journey, but they’re necessary. If the bank has pre-approved you for a loan of up to $650,000, don’t get too carried away when house hunting. It’s pretty easy to get carried away and make allowances for a house. So, if the phrase, “but it’s my dream house and only a few thousand more – we can make it work!” sounds a little too familiar, try and remember what you set as your limit. Even though the bank may have pre-approved you for that much, it’s important to go back to your budget as a whole and see how this figure (along with additional costs) would slot in.
Plan for interest rate rises
Interest rates are constantly on the rise. When you’re in the market for a new property, it’s common to get swept up in the heat of the moment – especially if there are low interest rates on offer. Try to think about the home loan long-term. If interest rates were to rise, would you still be able to service the loan comfortably? Generally, your lender will test your borrowing capacity by adding an extra 3 per cent on top of the current interest rates to gauge whether your income will still cover the cost of the repayments. When searching for property, add an additional 3+ per cent on top of what your current repayments would be if you were to purchase the property to ensure you’re comfortable with that amount if rates were to rise.
Consider the total cost of buying property
When you buy a property, it’s common to get tunnel vision and forget the total costs of purchasing the property. You might be able to service the mortgage repayments, but can you cover the extra costs like stamp duty, lender’s mortgage insurance (LMI), conveyancer fees, utility bills, water bills and furniture (if it’s your first home)? If you haven’t factored these extra costs into your finances, you’ll need to stress test your budget before making a decision.
If you’re looking to purchase a property – either for the first time, as your next home, or as an investment property – it can be easy to get caught up in the excitement of buying a house. If you haven’t stress-tested your budget before purchasing a house, you may find yourself under financial stress, making your new home seem not so great. Inovayt mortgage brokers have expert experience in stress testing your budget and mortgage stress tests. If you’re looking to purchase property, reach out to one of our team members today and find your next home sooner.